Fresh three-year lows, but late bounce helps tone

Kevin Pendley | Oct 06, 2008 4:36pm EDT | Comment

Rating: Unrated [rate it]

Small-cap stocks extended the decline Monday, starting out the week in much the same fashion as things ended last week. The latest selling spree was fueled by a global equities rout amid fears that the credit crisis contagion was spreading around the world at the same time that an economic recession was gripping the United States. The Russell 2000 (NYSE:IWM) shed 23.49, or 3.79%, to 595.91. At one point today, the Russell was off some 8% to an intraday low of 566.62, but the market had an impressive recovery bounce off the lows in the final 30 minutes of trading to take some of the fright element out of the move. That said, small caps still generated the lowest intraday price point in nearly four years, the sixth largest one-day decline of the year and the first daily close below 600 since May 2005. For the year, the Russell is down 22.2%, while the Dow is off 24.9% and the S&P 500 is down 27.9%.

The Dow sliced through key psychological support at 10,000 with surprising ease this morning, and at about the same time the Russell 2000 slashed through “figure” support at the 600 level. However, the dramatic late bounce in stocks lifted the Dow briefly back above the 10,000 barrier by the close. One veteran trader said that the ease with which the market sliced through 10,000 this morning was “scary” and that prolonged activity below that benchmark would be troubling in the days ahead.

U.S. equities walked right into a global storm this morning, with European stocks sinking some 5% into the open, on the heels of steep declines throughout Asia. Stock market trading in Russia was halted three times as major index products there tumbled over 18% during the session. Trading halts were also executed in Brazil as the world’s sixth-largest country saw stocks sink 15%. In Peru, trading was also stopped as the market slumped 7%. It was the worst one-day carnage in 10 years for Latin American stocks, evoking memories of the 1998 Russian default on Latin debt. The situation was dire enough that countries around the world felt compelled to respond publicly to the crisis, trying to reassure investors that their own Treasury resources could weather this crisis. Here in the U.S. President Bush addressed the crisis, saying that it would take time to implement the rescue plan signed into law last week, but that the U.S. economy would be “just fine” over time.

Many Latin American economies are heavily dependent on commodity exports and it was a brutal day for physical markets, as fears of a global recession coupled with rising U.S. dollar values dealt a powerful blow. The Commodity Research Bureau Index collapsed more than 5% to the lowest point since September 2007. Copper prices were off 7% to 18-month lows, crude oil was down 6% below $88 a barrel to eight-month lows and corn prices were off 6%, down their daily trading limit. Other markets limit down included oats, soybeans, cattle and cotton. Small-cap stocks have shown a tracking affinity with commodities in recent weeks, and with commodity themes getting hammered today, it took a toll on more than just financial firms already reeling from the credit crisis.

The Federal Reserve must have known it was going to be a difficult day for the market; right off the bat the Fed was busy injecting massive liquidity into the market. At the same time, central banks around the world were also busy trying to flood the market with cash and ease clogged credit lines. Despite the extraordinary moves, many market watchers are now saying that the Fed needs to cut rates again — preferably in concert with other major central banks around the world. Just ahead of the close, the chief at the largest bond fund in the world, Pacific Investment Management Co. (PIMCO), said that the Fed should purchase commercial paper outright and lower the Fed funds target rate to 1%. Fed funds futures were already fully pricing in a 50-bp rate cut in the October time frame, and actually moved to a 60% chance for a 75-bp cut as the height of today’s panic.

Speaking of debt markets, the desire for a safe-haven in these turbulent times sent money flow into Treasury markets, where the yield on benchmark 10-year notes (which move inversely to price) jumped some 3% in volatile activity.

The chart structure retains a powerful bearish stance right now in small caps, especially after violating 600 support today. There is logical long-term support in the zone from 677-670, so the stall point on the decline makes sense as a potential consolidation area, especially amid oversold momentum readings. What’s more, the nice late bounce off the lows produced a pattern similar to a “hammer” bottom on daily candlestick charts, and these formations are often seen at a major market low. Still, the path of least resistance is clearly toward lower prices and should be respected — especially if the market can’t sustain the bounce momentum Tuesday.