Should You Prepare for a Downturn in Key Stock Indices?

By Moe Zulfiqar

Two lines from the song “For What It’s Worth” by Buffalo Springfield pretty much sum up what we are seeing on the key stock indices here in the U.S. economy: “There’s something’ happening’ here/What it is ain’t exactly clear.” There is too much noise out there: some are sayingkey stock indices are going to head lower, while others are saying they have much more room to the upside.

In the summer, the bears said key stock indices would start to decline in the fall due to markets rallying on low volume. The bulls, on the other hand, insisted that earnings are good and consumers are buying, so a higher stock market is ahead.

From a technical point of view, there’s a particular formation that can be seen on this chart that’s not really talked about in the mainstream—a pattern called the “rising wedge.” According to technical analysts, this is considered a reversal pattern, meaning that it suggests the prices will turn in the opposite direction, heading lower from their current higher standing.

Some of the indications that the rising wedge pattern is in the making are the slowing rate of increase (gains and losses are smaller over time), the ideal three resistances on the upper trend line, at least two supports on the lower trend line, and the volume declining as the pattern emerges.

Please look at the chart of the S&P 500 below.

              Chart courtesy of www.StockCharts.com

But this is all too technical. In a nutshell, the fundamentals of key stock indices aren’t getting any rosier. Companies are warning about their earnings, the economy is growing slowly, the unemployment rate continues to be staggering, a record number of Americans are on food stamps—you get the picture.

What’s really next for the key stock indices?

It’s a well-known fact that the key stock indices were going higher due to the Federal Reserve’s money printing, but this has slightly changed. Not too long ago, we heard from the Federal Reserve that it won’t be stopping quantitative easing; the key stock indices went higher the day of that announcement, but have since been treading lower. The gains attained on that day are now all gone.

This shows one critical phenomenon: investors are realizing that the Federal Reserve will start to slow its quantitative easing—if not this month, then sometime in the future. As a result, they are selling based on any strength they see on the key stock indices.

As I see it, the key stock indices seem to be facing troubles ahead, but you have to keep in mind that markets can also act very irrationally at times. Is this one of those times? I don’t know, but based on what I have seen in the past, once the confidence starts to fade away, the key stock indices may head lower, only to pick up speed very quickly.

When it comes to investing for the long term, investors should be careful to not jump to conclusions. They have to evaluate the situation on their own and make sure to minimize their risks.

This article Should You Prepare for a Downturn in Key Stock Indices? was originally published at Daily Gains Letter