Saturday, 19 October 2013

5 charts to explain why I think US stocks may begin a 50% decline in the coming week

There is a good chance that US stocks peaked on Friday or will do so in coming days, and subsequently will begin a large multi year decline in the order of 50%.

Why do I think so? The first 3 charts make the case, showing that at 3 different time frames, major US stock indexes are positioned at or near major trend line resistance. The final 2 charts give us some levels to judge whether the early stages of a decline are in fact getting underway.

The S&P 500 weekly chart shows that the market is testing the illustrated trend line resistance zone for the eighth time since late 2008. Since the S&P has not beaten this resistance level in all that time, it is reasonable to look for a turn lower from current levels. Don't fight the tape / current up trend?? Yes, that's exactly what they were saying at the previous touches of this trend line, which were all exactly the right times to be looking for trend reversal, at least in the short term.

The S&P 500 daily chart shows the market testing another trend line resistance zone, supporting the case that a turn lower could be directly ahead.

Next chart zooms back out, to a long term view of the Dow Jones Industrial Average, illustrating a trend channel beginning in late 1987 after the crash of that same year. In recent months the market has tested the top channel line several times and been unable to beat it, suggesting that it is reasonable to look for a turn lower from nearby current levels. A move to the bottom channel line would require a decline of around 50%.

Now that I've made the case that the markets are well positioned for a turn lower, possibly ahead of a large decline, let's look at some yardsticks by which to measure whether a decline is beginning.

The Dow daily chart suggests that the lower trend channel line is key to any bearish case at this time frame and subsequently at larger degrees of trend. Of course you could make a similar judgement on the S&P daily chart shown above, but the Dow daily chart makes an additional key point, that the generals have left the battlefield. That is, while the S&P has soared to record highs this week, the Dow has not. Exactly the same thing happened in the periods prior to the 2000 and 2007 tops, which of course preceded large declines.

Finally the Dow hourly chart shows the market currently channeling in a weak up trend, testing yet another trend line resistance zone. A break lower from this trend channel could be the initial signal that the markets are turning down from larger degree trend line resistance. The flip side of course is that any sustained rally upwards from the trend channel will be a hint that the bearish case has failed for the time being. We'll know early next week.

ASX 200 weekly chart - again testing parallel trend line resistance, upside appears limited