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Is the Worst Over or Just Beginning?

SAN DIEGO (ETFguide.com) The last 12 trading days have erased more than one year of gains. One can't help but think about September/October 2008 when the Dow Jones (DJI: ^DJI) lost nearly 4,000 points, the S&P (SNP: ^GSPC) 400 points, and the Nasdaq (Nasdaq: ^IXIC) 1000 points.

Over the past two weeks the Dow has lost 'only' 1,600 points. Does that mean the worst is over or is the worst still to come?

Long-Term Outlook

A number of bearish events happened last week:

1) The Dow Jones broke through a trend line that has provided support on four occasions since the March 2009 low (see chart below).

2) Dow Theory registered a bearish non-confirmation when the transports hit a new high on July 7, while the Industrial Average was unable to beat its May 2 high.

3) The S&P broke below the neckline of a bearish head and shoulders formation.

In addition to the above, the S&P has been laboring on a multi-decade bearish M-pattern. The upper trend line of this bearish M pattern sliced through 1,377 in April. Important Fibonacci resistance was at 1,369.

This M pattern looked so esthetically pleasing (if you can use that term in connection with technical analysis) that the ETF Profit Strategy Newsletter stated on March 6: 'A major market top in the 1,369 - 1,382 range would certainly create a technical picture for the history books.'

On April 3, the Newsletter confirmed this outlook: 'In terms of resistance levels, the 1,369 - 1,382 range is a strong candidate for a reversal of potentially historic proportions.'

The ETF Profit Strategy Newsletter for August (released on July 15) provided more insight about the market's post-peak performance: 'The next bigger profit opportunity will be to the down side. A close below this year's low at 1,249 would probably mean that a major market top has been reached and should minimally lead to 1,229 or 1,170.'

The deterioration in U.S. markets along with emerging markets (NYSEArca: EFA) and (NYSEArca: EEM), wasn't just a fluke technical constellation. It was a man made (with 'man' I mean Fed) disaster.

Also on July 15, the Newsletter explained that: 'the Fed fueled a QE bubble to combat the damage left behind by the previous bubbles. Once punctured, bubbles tend to deflate quickly. We still anticipate a decline towards x,xxx (reserved for subscribers) starting in 2011-2012.

Short-Term Outlook

Those who don't learn from history are destined to repeat it. I'm not a big fan of cliches, but investors do well not to ignore certain historic patterns.

It's said that the difference between a smart and a wise person is simply how they learn: A smart person learns from his own mistakes. A wise person learns from the mistakes of others. Who does not want to be wise and learn from history?

The July 16 ETF Profit Strategy update featured a chart of the 2007 market top and stated: 'There is a striking similarity between the 2007 top and now. There is a similar trend line and a triple top above the trend line. A break below that trend line could be a precursor of bad things. Next week the trend line will be at about 1,262.'

As expected the S&P stair-stepped lower to 1,262 and fell apart as soon as it dropped below 1,262. We all know that history may not repeat itself, but it often rhymes.

Courtesy of the 2007/2008 decline we now have a script. Let's see how much lip the actors will add during the live performance (I.e. the downgrade of U.S. debt by Standard & Poor's).

As per the script we can expect a low that dips beneath last week's low, followed by an eventual rally that will test the trend line that provided support previously.

Dealing with the Unexpected

Will there be QE3? If so, how will QE3 affect stocks? We don't know. What we do know is that the world's industrial powers are already hoping that Europe's central bank will engage in aggressive bond buying (Europe's version of QE3).

What we also know is that every bounce in the stock market is now considered a dead cat bounce unless it carries above major resistance.

Should You Rush Into Gold

Gold (NYSEArca: GLD) has just spiked above a trend line that goes back as far as 2006. Gold (NYSEArca: IAU) is at a new all-time high, so aside from this trend line there was no overhead resistance.

However, gold is stretched and is susceptible to a potentially powerful decline. Such a decline could be triggered by a drop below the trend line. In fact, that's exactly what happened at the end of April. It's always smart to have some exposure to precious metals, but it's also prudent to have a plan B if things go sour.

Summary

Most investors should be in cash now. The ETF Profit Strategy Newsletter recommended squaring all long positions at S&P 1,340 on July 7. If you haven't had a chance to get out in time, the situation is a bit trickier.

Keep in mind though, that the time to sell is not when everyone else is panicking. The market is likely to provide an opportunity to allow investors to raise some cash at better prices somewhere over the next week or weeks.

Yesterday's special ETF Profit Strategy Newsletter update provides a short and mid-term forecast, along with a detailed comparison of the 2007 top and current prices, and the all important trend lines for the S&P 500 and gold.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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