Traders Bracing for Retest of January Lows

Regular readers of this blog know that I am a fundamental-based investor. As a result, over the long term the two key determinants of future stock price performance that I focus on are earnings and valuation. Although I strongly believe that technical analysis only works over short periods of time, in the absence of new material information, enough people read charts (especially traders, as opposed to investors) that they can predict near term market movements due to thousands of people acting on them in the same manner simultaneously.

I bring this up because when we got the huge leg down in January, which served as a short term bottom after the Fed temporarily rescued us with an emergency rate cut, traders were adamant that we did not see capitulation (Bernanke didn’t let that happen) and would have to retest the lows after an oversold bounce. Sure enough, we got a bounce up toward 1,400 on the S&P 500, moved along in a narrow 1300-1400 band for a little while, and now are moving back down to the lows, as the chart below indicates.

Let’s give the chartists credit for their call. Market bottoms often look like the letter “W” on a chart, a pattern I have noticed since I started following the markets. The next step is to see if we in fact retest the lows (we are a few points on the S&P away from the closing low of 1310 as I write this, but still a few percentage points away from the intra-day lows of 1270).

If we get a retest, followed by buying interest sparked by all those chartists salivating at a potential double bottom formation, we could certainly have another bounce in coming months. Depending on the economic and earnings picture at that point, it could very well give investors a chance to take some chips off the table. That is only one possible scenario, but it is the one bulls should be hoping for.

The S&P 500’s closing low was 1310.50 on January 22nd. Today the index hit an intra-day low of 1310.49 and has since bounced about 4 points.