Review of Thursday's Stock Market Massacre

Editor's Note: This article was written by Richard Suttmeier, chief market strategist at ValuEngine.com, which is a fundamentally-based quant research firm in Princeton, New Jersey, that covers more than 5,000 stocks every day.


My Take on Thursday’s Massacre

The stock market had been suffering from a case of complacency, ignoring overvalued and overbought conditions for stocks that led to short-covering, and the bulls ignored the debt crisis in Greece calling it "contained." Seems like we heard that story before when the problems in subprime mortgages wouldn't spread to the broader economy. It’s happened before in the 21st century:
 

• Remember tech was the "only place to be” in March 2000 with the NASDAQ above 5,000?
  
  
• In October 2007 with the Dow above 14,000 the bulls called it “P/E Multiple Expansion." By Thanksgiving 2007 we had a Dow Theory Sell Signal.
  
  
• This year I liked the Market for a trade on February 8 but on April 26 I cited that the Dow was testing its 61.8% Fibonacci retracement of the decline from October 2007 to March 2009. I suggested raising cash to 75% and provided levels at which to short DIA, SPY and QQQQ.
  
  
• On April 26, stocks were extremely overvalued and overbought and without major supports should a break occur. I reiterated my prediction "Dow 8,500 before Dow 11,500."
  
  
• Remember the meltdown of January 2009 into March 2009? When I called for a 40% to 50% rally on March 6, a poll on Fox Business Live had 88% in disagreement with me.
  
  
• I haven't always been a bear. Remember in the second half of 2002 and into October 2002 I was pounding the table to buy as investors were bailing out? I reiterated a bullish call as our troops began to march toward Baghdad in March 2003.

The bottom line is that when the short base is reduced and the bulls are loaded and don't have bids below the market, the only way is down when the crowd wants to exit.

“Good Until Canceled” (GTC) orders worked well in last Thursday’s volatility.

What we need is circuit breakers in stocks traded on the computer-only platforms. I'm an engineer by education with a Master of Science in Operations Research Systems Analysis. I designed simulation programs in the late 1960s into 1972. I know how computerization can be biased by the programmer's design. I've always opined that Black Box Trading should be banned. The fall-out from Thursday’s meltdown will only take more average investors out of the market, calling it a Wall Street-rigged game. High Frequency Trading needs a human touch or automated safeguards and the transparency to know that below a certain bid or above a certain offer there’s a price gap of x%. Knowing this information. these gaps are likely to be filled by willing flash traders. If not, there has to be a y% threshold where the system stops trading on a stock until liquidity returns.

Bank Failure Friday

Four banks were closed by the FDIC on Friday. While these were small banks, the cost to the Deposit Insurance Fund is now $9.6 billion in the second quarter and $16.1 billion year to date, which exceeds the total bank assessments of $15.33 billion for 2010. 1st Pacific Bank of California (FPBN) was on the ValuEngine List of Problem Banks.
 

• Only 25 banks failed in 2008, as the FDIC was slow closing community and regional banks.
  
  
• There were 140 bank failures in 2009 with a peak of 50 in the third quarter.
  
  
• In the first quarter of 2010 there were 41 failures, and so far in the second quarter the total is 27 for a year to date total of 68.4. At this pace bank closures will be at the high end of my 150 to 200 estimate.
  
  
• Since the end of 2007, the FDIC has closed 232 banks.

All four of Friday’s bank failures were overexposed to C&D and CRE loans.
 

• Overexposures to C&D loans were between 120.2% and 335.8%.
  
  
• Overexposures to CRE loans were between 653.2% and 1048.2%.
  
  
• The loan pipelines were 93.9% to 99.3% of loan commitments funded.
  
  
• The ignored regulatory guidelines are 100% for C&D loans and 300% for CRE loans.

Risk aversion has been my call with lower US Treasury yields, gold above $1200, crude oil skidding lower with the euro, and a new bear market for stocks. After testing its 61.8% Fibonacci retracement of the decline from October 2007 to March 2009 comes at 11,238, my prediction remains: Dow 8,500 before Dow 11,500.

Weekly Dow

The Dow ended last week below its 200-week simple moving average at 11,130, after testing the 61.8% Fibonacci Retracement of the October 2007 to March 2009 low at 11,246 with the April 26 high at 11,258. MOJO remains overbought, but will likely be declining below 80 next week. A weekly close below the five-week modified moving average at 10,799 shifts the weekly chart profile to negative. My annual pivot is 11,235 with monthly and semiannual resistances at 11,274 and 11,442. I still predict Dow 8,500 before Dow 11,500.