The day after the election the stock market had its worst day since November 2011. Stock market patterns give warning to the probability of a reversal in trend and a possible panic or crash. A classic patter is the Broadening Formation, which make their appearances only at the end of a long bull run.
By Anthony M. Cherniawski and Janice Dorn
Nov 09, 2012 9:00 am
Minyanville
In October, we published two articles suggesting that there might be a stock market panic in October. We were early. Whether the delay in the potential market panic was due to organic reasons, such as the excitement leading up to the November election, or some other factor is beyond the scope of this article. What we do know is that the day after the election the stock market had its worst day since November, 2011.
On that day, the S&P 500 (INDEXSP:.INX) decisively broke the Rising Wedge formation with a potential for a complete retracement to 1074.00 and the potential neckline (dotted line) for a Head & Shoulders Pattern with a minimum downside target of 1322.00. Either event could be construed as bearish -- but the combination of the two may be a disaster for the longs.
Warnings
In prior articles exclusve to Minyanville, we discussed stock market patterns that give warning to the probability of a reversal in trend and a possible panic or crash. A classic pattern is the Broadening Formation. These formations make their appearance as a rule only at the end or in the final phases of a long bull market.
One characteristic of Broadening Formations is that they become activated only upon the crossing of the lower trendline. Thus, you can see the larger Broadening Wedge Formation where the SPX has remained within its widening trendlines for almost an entire year. By early October, we were able to identify a smaller Orthodox Broadening Top that is a degree more aggressive than the Larger Broadening Wedge formation and with an easier-to-reach trigger point at 1395.00.
On Thursday, November 8, the lower trendline of the Orthodox Broadening Top was breached. In addition, The Dow Jones Industrial Average (INDEXDJX:.DJI), Wilshire 5000 (INDEXNASDAQ:W5000), Nasdaq (INDEXNASDAQ:.IXIC) Russell 2000 (INDEXRUSSELL:RUT) and S&P 500 all closed beneath their respective 200-day moving averages. You might say that the stock market panic button is about to be pushed.
Will History Repeat?
As Mark Twain once said, “History doesn’t repeat itself, but it often rhymes.” As the eye is drawn to the upper left corner of the weekly SPX chart, one sees a very clear Orthodox Broadening Top with the resulting decline into the crash of 2008. Today we don’t have only one Broadening Formation -- there are several! One may draw the conclusion that this time may be different -- but in the worst possible way for those who are holding long and hoping.
Have a look at the weekly chart of the 10-Year US Treasury Note Index (INDEXCBOE:TNX) It has the identical pattern as the S&P 500 Index. The Ending Diagonal portrayed in this chart projects a swift decline to its origin at 117.98. In the meantime, the Broadening Wedge has a good probability of being activated with a further decline projected beneath 100!
We believe that one of the reasons the Fed continues to be the largest buyer of Treasury paper is to keep bond and note values elevated above their respective long-term trendlines. Not only does the US government have to deal with the fiscal cliff, it also may have to contend with rising interest rates if the trend breaks down. Rising interest rates have the potential to blow up any attempt at balancing the Federal budget.
The Broadening Top Formations have “allowed” the bull market to extend beyond the point that many had expected due to repeated quantitative easing to reflate stock prices. However, there is a payback for these extensions.
Fundamentally, investors are now dealing with the looming fiscal cliff and the prospect of higher taxes on capital gains and investment income starting next year. Higher taxes and reduced spending of both private and public funds suggest an economic slowdown in 2013 that may make equities less attractive. The urge to take profits before the year end may turn into a panic as the growing number of sellers simply overwhelms potential buyers.
In summary, trigger points that have been identified in prior articles have now been crossed. If you have not already done so, it’s time to take appropriate action in your portfolios. Don’t be the last person standing when the lights go out after the panic button is pushed.
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