S&P 500 Double Top

The above chart is the S&P 500 Index (SPX) on a monthly basis from 1950 to present. (click on chart for a bigger version). S&P500 Index (SPX) Double Top

The two recent major tops obvious in the chart above occurred on 03/24/00 at 1527.46 and 10/10/07 at 1562.47. A Double Top as defined by Edwards and Magee in Technical Analysis of Stock Trends (1948) requires that the two tops "appear at the same level" which they obviously do. There must be a down move between the two tops significant enough so that the two tops cannot be considered part of the same overall "uptrend". Considering that the tops are over 7.5 years apart these tops easily meet that requirement. Lastly, in order for the Double Top pattern to be considered confirmed, the SPX must "drop through the bottom level of the valley", which is S2 in the chart above. There are many ways to answer when and if this occurs. The definition I'm using gave the SPX plenty of opportunity to reverse at S2 and move higher. Because the chart is a monthly chart, I required that a monthly close be obviously lower than the lowest intraday price of the SPX at the valley low point. That valley low point was on 10/10/02 at 768.63. The SPX closed the month of February on 02/27/09 at 735.09 which is clearly below the valley's intraday low. Therefore in my opinion, the Double Top pattern is clearly confirmed.

About the Double Top, Edwards and Magee state,

"...it is usually a signal of Major importance. Fully confirmed Double Tops seldom appear at turns in the Intermediate trend; they are characteristically a Primary reversal phenomenon. Hence, when you are sure you have one, do not scorn it. Even though prices may have already receded 20%, the chances are they have very much farther to go before they reach a bottom."

So what are the implications of the confirmed Double Top pattern?

The rule of thumb is to expect a move equal to the height of the pattern projected downward from the valley low. That implies a drop in the SPX to around 450.

The Long-Term uptrend in the SPX

As you can see in the chart above, the uptrend line S1 is drawn across the two major lows of my lifetime: 10/03/74 at 62.28 and 08/12/82 at 102.42. Just off the chart is the 06/13/49 low at 13.55 which is also very close to S1. The S1 line rises at a 6.5% annual rate. This is the historical appreciation rate of the stock market (not including dividends) over the period starting at the important low in 1949 after a few years of post-World War II sideways movement, and ending at the 1982 low which was the start of the Reagan Revolution and the dawn of the Personal Computer.

Extending S1 to the present, it is around SPX 450 which perfectly corresponds with the downside implcation of the SPX Double Top. One of the many ways the investment industry misleads people is by comparing performance at either random points that work well for marketing or by comparing buying at bottom and selling at tops. The reality is that stock market investor evaluating true risk/reward should compare apples and apples which in this case would be bottoms and bottoms. If we are looking for where a very important long term bottom should occur, it makes sense that it would occur on the 6.5% annual return line (S1) on which three major bottoms since 1949 also occurred.

The Long-Term Conclusion

After 17 years of writing to my clients, normally, this is the place where I'd say, "a drop to SPX 450 is likely". But I cannot get myself to say it. The implications of such a move are devastating for our country and for the world. It is a Great Depression type scenario.

I first wrote about this possiblity far before the second top was in place. Now, I've avoided writing this analysis. I've hoped and prayed that the market would turn and not confirm this pattern. As an entrepreneur, investor, and market timer who'd much rather be professionally wrong than see the majority fail, I'm angry. This market desperately needed encouraging words and wise action from our government. Instead, we got daily speeches from our leaders about how bad things were, that they'd surely get much worse, and how it would take years to recover. Even though some economists may believe that, others know that economies can turn around quickly, and economic predictions have less than stellar track records all of which are impossible to analyze. Have you ever seen an economist make his historical track record of failures and successes public information before presenting a market altering economic opinion?

The Last Straw

I was optimisitc. I really believed that once the Stimulus Package passed, the administration would turn vocally positive hoping to turn the markets before the S2 support failed. But instead, they want much more. Exactly at the critical point of testing the S2 support, we got the proposed federal budget that, in my opinion, is harmful to investors, markets, entreprenuers, business, and anyone who has succeeded financially. Heck, right at the S2 test we were entering the late February/Eary March period which has a huge bullish bias. It would have been easy for the administration to turn the market up at the S2 support enough to get traders short-term bullish and therefore move the market significantly higher.

At least that would have bought us some time.

However, it's my opinion that our President believes that the health of the stock market is less important than his agenda of Universal Health Care, Cap-and-Trade, etc. It's my opinion that our President believes that downward moves in the SPX are merely short term and only hurt the rich, and that his long-term policy goals are far more important. If that is truly the case I think he is dead wrong and even though the drop through the S2 support can be considered a short-term move, it's a very important one that could turn a recession into something far worse.

So finally I will say this...

No pattern, analysis, system, or prediction is more than about 75% accurate at best. We've had many false breaks to the upside lately and hopefully this is just a historical fake-out for us market technicians as well. The future is not set in stone and for the good of the majority I hope the scenario I've presented above is miserably misguided and wrong.

The SPX is Overdue for a Short-term Rally

Downside Gaps, which are days when the open is below the previous day's low usually indicate a market that has become too negative. When a market gets too negative it usually will reverse and therefore, gaps usually fill. (Ie. The SPX will usually move back up to the point where the gap opened.) We opened this morning (03/02/09) with a big gap and we still have two unfilled gaps overhead. The highest opened 0n 02/17/09 at SPX 825.21 as the SPX fell below well defined short-term support S3 just over 800. The SPX has also now fallen 11 of the last 12 days. Markets do not move straight down and this market is far overdue for a rally.

Therefore... The SPX should move up to retest S3, attempt to fill the gap at 825, but be pushed back down by the downtrend line that is forming (R1). I would not be surprised to see the SPX move up to almost 825 in a huge early rally that ends up being a key reversal with the close right on S3 at 800. (A Key Reversal is a day that moves substantially higher early in the trading day and then collapses later closing right around even or even down slightly.)

Conclusion...

As most know, our capital is mostly managed by the mechanical stock/gold market timing systems and strategies we've developed in ULTRA 10, and which have performed very well. However, we do manage some capital using straight technical analysis, which is the analysis of price charts. For that capital, we entered this market long around SPX 850 hoping for a long-term buy at what we'd thought was support that would hold. We've now given up and are looking to exit to 100% cash. It almost never pays to sell out in a downside panic so we'll be a little patient. As I said, I expect this market to rally in the short term and make a run at filling the gap at 825. Therefore, we'll sell all our non-mechanically managed accounts to 100% cash at the next close over 800.

And Lastly...

Most of the people who've read my writing over the last two decades are highly sophisticated investors, money managers, and traders. Since this is the first time my analysis will be available to the public, I want to make an important statement. Do not use my words to panic out of the market. There are tax issues that probably concern you and even if the market falls much farther, you will still need to re-enter down the road and that will be a difficult decision to make. Also, there's at least a 25% chance that I am dead wrong. I'm perfectly willing to be wrong and forced to re-enter at higher levels. The worst thing a long-term investor can do is panic sell and then miss the recovery. Hoard cash and get ready for the buying opportunity of a lifetime down the road.

Good Luck,

Steve Hunter, ULTRA Financial Systems LLC

http://www.ultrafs.com/