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Monday, April 1, 2013

The dilemma of major tops and bottoms

I started studying the stock market in the summer of 1998.  I began by reading many books and studying stock charts through the Telechart software.  It just so happens that late that summer and fall the market had a 20% sell off.  Here is the SPX chart from that time frame.

The green arrow marks the day I realized we were starting a new bull market.  By that fall I had figured out the 4 year cycle and knew about 9-1 up days (up volume 9 times the down volume).  That was an easy one to figure out.  I told a few friends about it, but I don't have any other proof.  Lets look at the 2000 top.

The red arrow is about the time the light went on that we were in a bubble.  It was obvious when market valuations were totally and completely out of whack and every TV in every bar or restaurant was tuned to CNBC.  If that was not enough just look at the parabolic up move in the chart.  I started telling everybody I knew what I thought.  Talk about a hard sell, LOL.  Most people just laughed.  I don't have my emails from that time period, but sometime in Aug. of 2000 I wrote a note to all my family members that I thought a 30-40% decline was coming.  I underestimated the loss a bit.  I recognized a major top and bubble was forming way back in Jan. of 2000, but the bear market did not start in earnest until Sept.  That was about 8 months after recognition of the coming turning point.  Moving on to the next major point.

The green arrow is for 7/24/2002.  I wrote these words to my friends.

"I just wanted to step out on a limb and give you guys a heads up.  Human sentiment has finally come in line with market technicals to give us a good chance of having a meaningful market bottom.  We had a multy day
waterfall decline with coverage on nightly news, today show, radio, and Jay Leno made shrinking portfolio jokes all week. The volume pattern is also excellent.  I would expect to see a retest of the low in the future which could be as short as 3-4 weeks or as long as 3-4 months.  However, I would say that the low will hold on any retest and we may not get all the way back to it."

That low was retested in Oct. and a slightly higher low was made in March of 2003.  It held each time and eventually the bull market took off in earnest.  This time it was about 9 months after point of recognition before the final low.  Moving on again.

The first red arrow I wrote this to my friends.

"The good news is, SPX bounced off the 1534 support level and
mounted a decent rally going into the close.  The bad news is,
the number of new lows has continued to rise over the last few
days.  Also, the number of stocks above their 200 day MA is at
the lowest level all year.  Even though the major indexes are
near all time highs the number of stocks still in an uptrend has
definitely diminished.  IMO, this is the weakest position the
market has been at the highs this entire bull market.
 It looks
like we could be in the process of forming an important top.
However, the major indexes can continue up for some time
even as the internals continue to weaken.  I will be keeping an
eye out for a breach of an important support level (SPX 1534 at
the moment).  We need to get some good volume and breadth
on the upside to get this market on better footing."

That was when I started to think we were going to make a major top.  Here is what I wrote at the second red arrow in Oct. that year.

"A key reversal day up launched this bull market on Oct. 10, 2002.
Today is the11th and we had a key reversal day down (5 years almost
to the day).  The charts look very similar flipped upside down.  A double
bottom then, a double top now.  I can't recall seeing market internals
collapse as fast as they did today.  The afternoon selling was broad based
and on high volume.  I see key reversal days in a lot of stocks including
IBM.  I have pointed out how the last sell off was different then the others
in this bull.  We now have had a retest of the highs with many technical
divergences.  They have been parading people on TV lately telling us how
great things are.  Not to worry they say, the global economy is stronger
then it has ever been.  History shows major tops happen when things
are good and can't get any better.  Bottoms happen when things are bad
and can't get any worse.  When I look at the charts I see the developed
nations were in bubbles at the 2000 high.  Today, I see the emerging
markets in bubbles.  China and India from 2002-2007 look eerily
similar to the NASDAQ from 1994-2000.  I was expecting the final top
next year, and that may still happen.  However, today's reversal could be
the end.  As I have said many times before, tops are harder then bottoms.
It is clear with the action over the last few months that the market is in
the process of forming a very important top.  I strongly suggest you
look at the risk in your investment portfolio and think about reducing it.
The older you are the more important it is not to loose money.  I have
outlined the down side risk.  I am very confident there will be a major
move down, I just am not sure if we have hit the final high yet.  The
technicals are in place but I have not seen that magazine cover or
newspaper article that often marks the final highs."

I never saw that magazine cover, but it was the final high.  It may have happened though and I just never heard about it.  That was only 3 months after the point I realized a major turning point was coming.  Now for the problem turning point.

The first green arrow I wrote this.

"The current decline is showing some signs of accumulation in the market.  This may mean that we will get a successful retest of the Nov. low.  That could spring a more significant rally then we have seen so far.  The sentiment picture is really screwed up for a major low.  I have never seen anything quite like this.  I am not sure if we are going to crash some more or rally like crazy, lol.  It does look like a big move is not far off."

Clearly I was having trouble sorting out what was happening.  In fact the market made a big move down and then up after that note.  No wonder I was confused.  On the second green arrow I wrote this.

"After most indexes hit new bear market lows yesterday, I was wondering what I would hear this morning on TV.  Instead of the usual talk about if this is the bottom, they were busy telling us why it was not.  This is real progress.  March is famous for multi month turning points, so I think it is likely we will get a low some time this month.  That could set up a rally into May and possibly even into July/Aug."

I recognized we were set for a rally, but the normal technical divergences at a final low were not in place.  Therefore I could not say if we were starting a new bull market or not.  I was really expecting we would retest that low or at least have a deep pullback to setup a normal major bottom pattern.  That obviously did not happen.  I did a lousy job of recognition there, I cannot deny it.  I was expecting some kind of retest of the Nov. 2008 low to be successful and show some divergence to launch a new bull market.  I could not understand why we went so far below the Nov. low (10%).   Then when we did bottom we made a V out of there with no clear sign that was it.  Here is a chart of the divergence between NDX and SPX that I noticed at the time.

The NDX index did not make a new low while SPX went significantly below its Nov. low.  I wondered at the time whether this was significant or not, but I could not find any similar situations to compare it with.  That turned out to be very significant afterall.  Check out the current chart.

The exact same divergence in the opposite direction is present today.  We are in the same month, just four years later.  SPX is up about 6% above the Sept. 2012 high which is a little less then the 10% it was below the Nov. 2008 low in March of 2009.  Lets look at a snippet of what I wrote in 2007 again.

"A key reversal day up launched this bull market on Oct. 10, 2002.
Today is the11th and we had a key reversal day down (5 years almost
to the day).  The charts look very similar flipped upside down.  A double
bottom then, a double top now."

Flip today's charts upside down and they would be eerily similar to the 2009 low.  We clearly have bull market top sentiment and margin debt today.  Is it possible we are making the final high?  This bull market kicked off with a big gap up that was never filled.  Will it end with big gap down that goes unfilled?  There are internal measures of strength like the Summation index and the number of stocks above their 200 MA that is very uncharacteristic of the final high.  However, those same measures were also not characteristic of the final low in March of 2009.   That was part of my confusion at the time.  Normally the final high and low of a trend show a high degree of exhaustion.  We did not have that in 2009 and we do not have that today.  We are likely in a global recession already, and we have had two quarters of negative earnings growth.  I think it is impossible to say this is not going to be the final high at whatever level we finally correct from.  That is the dilemma.


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