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As We Enter the Closing Quarter of 2011, What's Next?


The end of the third quarter will definitely make the history books for one in which volatility reigned. Here's what we have to look forward to as we enter the fourth quarter.

"Change is the only constant. Hanging on is the only sin."
–Denise McCluggage

The end of 2011 Q3 will definitely make the history book for one in which "volatility reigned." With the SPX ending down -7.1% for the month, -12.5% for the quarter and -17% from the May 1 high it's easy to remember why RISK -- not return -- is the metric by which investors need to calibrate their yardstick. Over the past few weeks, since penning the official start of the New Cyclical Bear Market (8/29/11), I've been discussing the atypical structure (here and here) that tends to follow as things get progressively worse. As discussed, the second phase/structure the markets are currently in is "disbelief" and represents itself as a volatile channel in which the second stage of fighting between the bulls and bears commence. As evident, the second stage is quite a battle versus the first stage. (First Stage: consolidation period prior to the beginning "massive" sell-off which initiates the cyclical bullish to bearish change of trend – "The 2011 Channel of Indecision.") Nonetheless, when this battle ends, the true "broad-spread" understanding begins.

Click to enlarge

As we enter the closing quarter of 2011, and traditionally the worst month of the year for equities, all eyes will be focused on the 1,120 Floors & Ceilings neckline for a holding point. It is only when this line succumbs to the pressure that the next stage commences. Again, this is where disbelief turns into reality and is represented in "Fear" (illustrated in Jeff Saut's work). When this happens it is more than likely it will occur with another straight-shot selloff which will bring the markets down to the next Floors & Ceilings around the 1,020 – 1,040 level. And, not unlike our current 2nd stage channel, this could present months of more sideways action combined with exceedingly fast runs toward the original breaking point.

Once entering and potentially demonstrating more months of volatile action – retesting the original break – the downward sloping Cyclical Bear Market Trend should appear. Up until this point all we know is that the cyclical trend has changed. Until the new trend becomes evident it is difficult to navigate and nearly impossible to tell when it ends. Understanding this stage is crucial.

With the leaders of late (NDX) now finally succumbing to the pressure of the broader tape, a break of 1,120 seems almost inevitable. (Examples of stocks which were or are holding on: Amazon (AMZN), Baidu (BIDU), Green Mountain Coffee Roasters (GMCR), Apple (AAPL), IBM (IBM), Starbucks (SBUX), Costco (COST), Priceline (PCLN), Expedia (EXPE), Biogen Idec (BIIB), Whole Foods (WFM), Alexion Pharma (ALXN), Cerner (CERN), Dollar Tree (DLTR), Intuitive Surgical (ISRG), Ross Stores (ROST), Bristol Meyers (BMY), Bed Bath & Beyond (BBBY), Check Point Software (CHKP), and O'Reilly Automotive (ORLY).)

Remember this: When the bears come and raid the house, they end up getting everyone. When a bear first begins, investors (individuals and institutions alike) reallocate assets to the strongest relative strength names in attempt to find alpha. Once the rationalization of the bear market finally hits the masses, all the cards begin the fall.

The ensuing drop through 1,120 will most likely be another 9% before any true support. Many, including us, hope this will happen as before – a quick rip-off of the Band-Aid and straight down.

I hope this helped. Good luck and keep your wits about you!

Editor's Note: Read more at Tuttle Asset Management.

Twitter: @TAM_News
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No positions in stocks mentioned.

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