Economic Weakness May Be Spreading

If Cisco’s dismal earnings report couldn’t sink the market, who would have bet on the Fed’s beige book doing it?

The survey of regional economic conditions is largely anecdotal, but investors didn’t like yesterday’s anecdotes: economic weakness is spreading well beyond manufacturing, and consumers are beginning to reign in their spending.

That’s just about the market’s worst nightmare right now, that weakness in technology and manufacturing may be spreading to the broader economy.

The results, as we pointed out in last night’s Market Close, was widespread technical damage to the major indexes. And since the technical signals given during a major turn window were unmistakably bearish, the evidence suggests that the trend for the next 2-3 months could be down. About the only good news is that another day or two of downside could be enough to produce an oversold bounce.

We’ll start with the bullish case, which is still a possibility despite the technical breakdowns. In the Nasdaq chart below, you see a narrowing set of downtrend lines called a falling wedge, which can be bullish because it means that the decline could be running out of room. That lower wedge boundary at 1870 would also meet the minimum downside target of the head-and-shoulders top broken in June.

However, one big caveat is in order: falling wedges have yet to work in this bear market. The latest, in GE , has been breaking down the last few days (see chart below).

The market’s other leaders don’t look too great either, as we’ve been saying for some time. The worst-looking chart belongs to Microsoft , which broke down out of a huge rising wedge recently and may be starting to roll over (see chart below). There’s no pulling punches on that one: taken literally, that rising wedge predicts an eventual move to 40 or lower. As we said on Monday, software stocks could lead the next leg down in the market.

In the near-term, one target for the market looks pretty clear: the Dow looks like it’s headed for a retest of the March-April 9100-9400 lows, based on an almost imperceptible breakdown out of a consolidation pattern yesterday (see chart below).

The April lows on the S&P and Nasdaq were 1080 and 1619, respectively, and a retest of those levels is not out of the question either. So how low could the market eventually go? One method that has worked well in this bear market is the measured bear move, which simply duplicates the previous major move down from the most recent peak. Looking at the S&P (see chart below), if the previous 300-point decline were duplicated from the May 22 peak of 1315, the index would be headed for about the 1015 level, implying lower lows on the Dow and Nasdaq too. If weakness is going to spread to the old economy stalwarts that have so far been holding up well, those targets could well be exceeded.

The big unanswered technical question for the market has been whether this is a major bear market for technology only, or the start of a major bear for the broader market. The next couple of months should provide the answer to that question.

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