October 2009 Technical Outlook for Stocks

— “Profit Confidential” Column, by special guest columnist
Anthony Jasansky, P.Eng.

A month ago, in my September technical outlook for stocks, I concluded my commentary by saying that I expect a very ugly September and October. As of writing this article, I can say “so far so good” or, more precisely “so far as bad as expected.”

The setback in the stock market the past couple of weeks is a much overdue correction of an overextended and over-priced market, also helping to chill out animal spirits that have re-emerged only a few months after the market meltdown came to a halt. The big question now is: what will be the depth of correction?

Considering the strength of the advance of the stock market from the March 2009 lows, and unlike many other market analysts, I believe that this correction is likely to be followed by another upswing above the recent recovery high of September 23, 2009.

There is no foolproof method to project long- or short-term targets for market indices or stocks. However, various technical methods can be used to make “educated guesses” as to where the market is likely to run into resistance or find support.

The large completed Head-and-Shoulder (H&S) formation of S&P500 can be used not only to derive the long-term upside target of the market, but also to estimate the depth of pullback following the July 2009 upside breakout of the neckline.

The distance between the low point of the head and the neckline added to the point of breakout yields the target of approximately 1,200-1,230 on the S&P 500 itself. That is about the level of the “Lehman’s-inspired” panic of September 2008, and also happens to be a 61.8% retracement of the 2007-2009 market collapse. A word of caution: this H&S pattern has one weakness, namely the absence of a volume spike during an upside breakout.

Initial breakouts of an H&S formation are frequently followed by pullbacks to the neckline or, in rare cases, marginally below it. Under this scenario, the pullback should not be deeper than down to 950-960 on the S&P500, or about seven percent below where the market currently sits.