Market Down mildly after U.S. Debt Downgrade but More Downside Likely Ahead

We can’t be sure about anything. Forecasting is all a game of probabilities. There’s no certainty in any of this.

All we can do is forecast based on evidence of what we’re seeing. So what is the strongest piece of evidence we have that the market is going to all time highs? It’s the size and scope of the rally we’ve seen off of the lows and the QQQ busting through ALL critical areas of resistance.

So I’ve personally seen this type of thing first hand on repeat like groundhog’s day. Almost all corrections lead into a full blown v-shaped or w-shaped recovery. And in all corrections, there are always lines of resistance including final lines of resistance before a return to the highs becomes pretty much inevitable.

For this correction is was $493 and confirmation above $500. Those were the final lines of resistance for the bears. Failing to hold the line at those points pretty much paves an open road back to the highs.

You have to open a chart, look closely at past corrections and note exactly where it is the market was determined to go back to the highs. It’s always when the last line of resistance is crossed or taken.

Resistance and support lines are determined by previous visits at those levels. For example, suppose Stock Z falls from $100 down to $72 a share during some correction. It later rallies to $130. The next time the stock falls in a major correction, $72 will represent a major area of resistance. Because that is the place the market last bottomed.

If Stock Z experienced a two legged correction during that first $28 sell-off bottoming at $80 and peaking at $90, well then $80 and $90 also represent areas of support. And on the upside, resistance.

For this correction, the key lines of support/resistance areas were $500, $493, $467 (bottom of leg 1), $477 (upper gap-line liberation day), $460 (lower gap-line liberation day), $448 (50% retracement for Leg 2) and $402 (lows).

Once the QQQ cleared ALL lines of resistance for the entire correction and further retracted a full 87% of the entire correction, that’s strong evidence pointing toward the highs.

Now obviously, there is a possibility that the QQQ could simply be just ‘retesting’ the highs. When you look at past corrections, v-recoveries can result in one of two outcomes.

First, and far more common, the market returns to its highs and goes on to make substantial new highs. That’s the default scenario. The market is pretty much in a never ending uptrend. That’s part of what it means to be in a bull market. You make new highs after corrections.

Second, the market fails its retest of the highs by falling just short of the highs or by forming a double-top at the highs.

Scenario two is far less likely to occur especially there has been a massive rally back to the highs. This plays a key role in the outcome. The market has rallied from $402 all the way up to $522. That is a 30% move to the upside. A double-top failure or the market falling short of the highs would require an even larger move to the downside. Where is that momentum going to come from?

It’s very unlikely that the market rallies 30% just to form a double-top. Often in this situation, it’s maybe a 10% rally back to the highs. A 30% double-top is crazy and often only occurs if there are very serious issues in the market like during the financial crisis. We’d need fundamentals to deteriorate to those levels. Otherwise, how else are going to get another 35% correction after we just went through one and the market has nearly fully recovered. And if those problems exist and they’re well anticipated by the market, why return to the highs at all? There were plenty of better places to peak — $448, $460, $467, $477, $493 etc.

We don’t have the supply to get there. The larger the recovery, the less likely scenario 2 plays out (double-top and/or retest scenario).

That leaves us with a return to the highs. Now we could see a correction sure. It’s possible the QQQ could pull back to fill last Monday’s gap. basically, a correction would imply reverse last weeks’ gains. We could see a sell-off down to $488. That’s one possible outcome. But after that, we likely go to all-time highs. Chances are, if you get a sell-off down to $488, we’ll see deeply oversold conditions setting the market up for a rebound back above $500 and once the happens, the market likely rips to all-time highs right after.

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Go back and look at past corrections and recoveries and you’ll see what I mean. In most cases, the market sustains a correction and either forms a v-recovery back to the highs like we’re seeing now or a complex w-recovery back to the highs as we’re seeing now. You’ll see there’s always a point where a return to the highs becomes fairly inevitable. That’s kind of where we are right now.