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Charts Urge Caution


Next drop off could be significant.


Professor Greg Collins compiled a sterling group of charts in Technical Analysis of Choppy Markets that I would like to expand upon. From Professor Collins:

A look at the S&P 500 Index (SPX) suggests extreme caution is warranted here. I've outlined the two-headed monster (a double head and shoulders pattern). Also evident is a base on top of a base and the stochastic divergence back at the peaks. If we take the distance between the top (~1,570) and the neckline (~1,370), the chart implies a break could take us back toward the 1,170 level. That's not to say that's where the market gets to or stops at - it's simply an area of initial support implied by the charts.

Click here to enlarge image

(Editor's Note: Professor Collins would like to point out that all charts in this piece reflect closing prices as of Monday, March 10th and thus do not include yesterday's rally.)

We cannot ignore the technical damage that has occurred. The markets just broke a major neckline / shorter-term wedge pattern. We have clearly broken the bullish trend off the '03 low.

There were four more charts in Greg's article and every one of them is worth a look.

We are singing the same cautious tune at SitkaPacific and see initial support at 1100 on the S&P 500. That's a long ways off from here, however, and the technical picture could change long before we get there. As of right now, however, my firm agrees with the idea that the technical damage that has occurred that cannot be ignored.

A Third Opinion

I emailed Greg's post to a friend of mine who is also a good chart reader. Here was the reply from "BV", along with two charts, the first annotated by me:

Great analysis. Thanks!

If the next larger-scale double bottom in the 1270s area were to be taken out, the measured move target would be the ~1140s-50s (to the 2005 lows). This would track the SPX during the early phase of the 2000-2002 bear market period, i.e., aligning with Feb.-Mar. 2001 technical indicators, including the monthly MACD, slow stochastic, and RSI.

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P&F Target

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Real Returns Negative

The 10-yr. real avg. annualized change of the SPX turned negative quite recently for the first time since 1973-83, the worst period of the last secular bear market for real total return.

Similarly, the Nikkei's 10-yr. real changed turned negative during the cyclical bear market of '97-'98 within the ongoing secular bear market in Japan at the time, coincident with the onset of the Asian Crisis.

Also, the Fibonacci retracement levels from the last low of the cyclical bear market to the recent cyclical high are ~1260s, ~1170s, and ~1070s.

Financials appear to be weakening again, leading the rest of the market lower.

Despite the gargantuan rally on Tuesday, new highs were virtually non-existent, and new lows expanded from Monday.

Finally, the historical self-similar secular bear market average trajectory (including for the Nikkei) implies a decline below SPX 1100 as early as this spring and more probably by late summer through yr. end and early '09. The decline could reach the 800s-900s or back to the '02-'03 lows.

A counter-secular rally would then be expected back to the 1250s to ~1300 area in mid- to late '10s to early '11, before the final descent into the secular bear market low and inflation-adjusted lows in '12-'14 to the 800s-900s again but perhaps as low as the 500s-600s, depending upon the US$.

Chart watchers will also note that Asia and Europe are following through to the downside. The Nikkei is down 31-32% from the cyclical high of 18,300.

Nikkei Weekly

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UK $FTSE Weekly Chart
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UK $FTSE Monthly Chart

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If support at the current level does not hold, next support is 1000 points lower and a move back to the 2003 bottom is 1000 points lower still.

Shanghai $SSEC Index Weekly

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Shanghai is setting up for a further plunge to 2900s-3200s or a 45-50% decline from the bubble high. Eventually, Shanghai could decline all the way back to where the bubble started below 1000.

Bullish Divergence On The Nasdaq

Just to present the other side of the coin, there is a bullish divergence setting up on the Nasdaq.

Following is a chart of the $NAHL (Nasdaq new highs minus new lows). The $NAHL showed a bearish divergence in October but is showing a bullish divergence now.

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Notice how almost no new highs were made on the Nasdaq as it topped out at 2861. That was a very bearish breadth indicator showing there was little participation in the runup.

The reverse setup is happening now as far fewer stocks are hitting new lows even though the Nasdaq fell to a lower level.

Don't Expect A Straight Line

There you have it. It is what it is and most of it isn't pretty. The equity markets that were all correlated on the way up are now correlated on the way down. Extreme caution is warranted.
However, no matter where we are headed, one thing is certain: We are not going there in a straight line.

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