Ugly stock-market action may result in attractive buy opportunity

It used to be said that if the U.S. markets caught a cold the rest of the world would catch pneumonia. In today's world, the U.S. remains the big dog but more and more, the world effects on our internal economics grows greater and greater. In Wednesday's "Silent Crash" article the hypothesis was that the U.S. markets were likely to be enveloped in the selling that was already well underway around the world. Last week's "Stock market breakdown article also outline the heightened and immediate risks we faced. That was the bad. Yesterday was the beginning of the ugly.

Remember, neoclassical thought says you can't get a correction, let alone a bear market, without a break of multiple swing points across multiple time frames. It's is a basic tenet of the model and yesterday we got the first piece of what today is likely to be that scenario.

Breaks on swing points on S&P

The breakdown on the short term time frame is now actualized and, if price holds lower than the swing point lows shown in the following chart, then we finally have multiple breaks of multiple swing point lows on multiple time frames. That is the ugly.

Breaks on swing points on S&P actualized today?

And the ugly is happening across sectors and indexes here - just as it has happened elsewhere already in the world. We are catching the cold from over there now.

The good is that this simply is the cleansing needed to provide better entry points for longer term investors. I know that everyone likes to think crash when the proverbial stuff hits the fan, but a cleansing is a good thing - not a bad one. It's just feels bad while being administered. What is being said here is a correction - not a bear market - might just be the outcome when it is all said and done which was outlined a little over a week ago in "Stock-market technicals suggest a breakdance lower."

As for near term outlook, assuming these breaks of the swing point lows on the weekly time frame remain in place through today's close, that makes for a 90%+ probability of at least 2 to 3 bars sideways to down on the weekly time frame. The likely scenario in this case, and in neoclassical terms, is for a successful bearish retest and regeneration attempt. Essentially it looks something like this:

  1. A breakdown (happening now) with trend transitions and likely two to three weeks of down
  2. A bounce that retests into the prior swing point lows that was broken in #1
  3. A failure of that bounce to get above and stay above the highs of the swing point low bars broken in #1
  4. Another drop where stocks break to even lower lows

If this does unfold, and it is highly likely on bearish breakouts involving multiple swing points, then the ugly will most likely play out. That, however, will eventually set up the better buying opportunity for those who have moved at least some of their holdings to cash over the past week or so when the alarm bells sounded.

This article originally published on MarketWatch on Aug 21, 2015 10:39 a.m. ET