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A Megatrend Reversal?


Head-and-shoulders bottom has investors all lathered up.

Bullish investors who subscribe to chart patterns are getting all lathered up over the prospects of a major head-and-shoulders bottom.

As readers know, I'm not a chart-pattern guy: I don't find the craft as providing a high degree (>70%) probability of successful calls. As a predictive tool, there's too much predictive inconsistencies for my comfort. That being said, just because I can't find a way to make it work doesn't make it completely invaluable. For starters, many others do, which in itself has value: When enough of the crowd follows a rule, no matter how low the predictive value might be, an investor would be wise to seek ways to exploit it.

There is, however, another -- and I believe more powerful -- reason to respect chart patterns: They may coincide with other, more high-probability technical-analysis tools. In this case, what I'm referring to is a potential mega trend reversal (from bear to bull), which may be underway and acting in potential concert with the aforementioned head-and-shoulders bottom. The combination of the 2 is a rare occurrence, and one that investors can ignore at their own investment peril.

The following chart illustrates this quite nicely.

At approximately 935, the S&P 500 is sitting at the edge of completely a head-and-shoulders bottom, precisely at the point of potential mega trend reversal. Should the market stage a strong upside move, similar to what emerging markets (EEM) has done (see chart below), no doubt more than a handful of market technicians will sound a clarion call to bullish arms.

Investment Strategy Implications

There's an old stock market adage which cautions against predicting a head-and-shoulders pattern before it's occurred. Better to wait until what might happen has happened. Then again, Sun Tzu advises that every battle is won before it's fought.

Given the confluence of both a potential head-and-shoulders bottom and a potential mega trend reversal, it would be foolhardy to ignore the potential power of both technical-analysis tools occurring simultaneously. Moreover, with emerging markets leading the way, ignoring such signals -- regardless of the real economy realities and risks -- is done at one's own investment peril.

As someone who is currently managing money at less than fully-invested (average 88-92% of total investible financial assets), I for one will be watching this very closely, and stand ready to ramp up the equity exposure as needed.
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No positions in stocks mentioned.
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