Thursday, March 27, 2014
The top chart is an hourly bar chart of the cash S&P 500 covering the past two months. I have highlighted a clearly defined, potential head and shoulders top which has formed during the past 10 days. This morning the market started to break below the neckline (red line) and if it makes further downside progress the breakout will become very obvious. It would probably be followed by a move down below the blue line which delimits the lower boundary of the trading range which has formed this past month.
Such a breakdown would be very bearish, especially in light of the point and figure chart which is second from the top. I have illustrated with red rectangles the extent of each of the tops during the past year. You can see that the sideways movement of the past month is by far the largest of these. A move down out of this sideways period would then mean that a drop bigger than any of the past year or two, indeed bigger than any since the 2011 drop, will be underway.
The bottom two charts also underline the bearish significance of a break below the low of the March trading range.
Both of these charts show long term bearish divergences between the Dow and the S&P (which have moved to new highs steadily over the past year) and the smoothed reading of daily new highs and of the number of stocks in the S&P 500 which are trading above their 50 day moving averages (these two indicators have not made new bull market highs). This is especially worrisome in light of the fact that the current bull market has lasted 5 years, exactly the length of the already abnormally long 2002-2007 bull market.
So far I have been talking about bearish potential. There is still a chance that this potential will not be realized and that new bull market highs lie ahead. To inform this judgement I will be watching the middle two charts which show the Dow and the S&P 500. If both of these aveages slide below their 50 day moving averages (green lines) I think the stock market's goose will have been cooked. A drop of 20% or more will probably then be in the cards.