Wednesday, 3 August 2011


The third 'Head-and-Shoulders' pattern in three years.
In contrast to June 2010 when I posted a similar chart, mainstream financial media 

don't seem to have made much of it:
if this is an indication of trader complacency, we're in trouble.

Just a couple of days after I posted warning of an on-coming economic train, the world's stock market investors have begun sending out signals of distress like they're tied to the tracks.

I'll shortly be posting some of the charts I watch most closely, all of which are now telling a similar unsettling tale, but I think it's important to alert you to the immediate danger - a swift drop in the S&P500 (and correlated markets around the world) of approximately 10% from current levels. 

The chart above is a little busy, but rather than risk some readers wandering off to make coffee and watch Celebrity Apprentice I'm trying to keep this as succinct as possible.

Essentially, there is risk of a crash here.  

My fears are these:

1.  Complacency is remarkably high in the face of a persistent sell-off, as demonstrated by various poular sentiment measures.  Without the onset of serious fear or panic, the market will not be able to find a lasting bottom. 

The Equity Put-Call ratio measures the desire of traders to protect themselves from downside risk.  Right now they're not that concerned,
suggesting many are counting on a bounce.

This is a recipe for a continued sell-off.

2. Liquidity is limited following the end of QE2, and QE3 remains a trader's distant dream.  The amount of cash held at mutual funds is at historic lows, thus providing little fuel for buying and little ability to fund investor redemption demands except by selling.

3.  European political leaders appear struck dumb in the face of a vicious market sell-off.  Many major banks are in near-meltdown.  Where is the leadership?  This can only inspire further selling.

4.  The price patterns suggest a high probability of going lower, either imminently or after a modest bounce.  We now have a sequence of lower highs and lower lows in the major indicies, defining a new downtrend, and the bull market's 28-month long trendline is definitively broken. Further, tests show the head-and-shoulders pattern to be around 70% successful in breaking down to its technical target (the two recent failures in the daily charts may have lulled investors into complacency).  Also, a break of the 200-day moving average after a very long streak above has often led to a strong bounce, but notable failures include the horror crashes of 1929, 1946, 1962 and 1987.


Investors are reacting to two major  macro developments - a sharply slowing world and US economy and the potentially disastrous situation unfolding in Europe.

In the face of these conditions, I am expecting to see lower prices ahead even if we get a bounce over the next few days.  With risks markedly heightened, I see absolutely no reason to stay invested on the long side until we see evidence of investor panic and /or a marked drop-off in selling pressure.  So I'll be using any minor rebound here to liquidate longs.  Meantime, I remain short the major European, Brazilian and Chinese stock indexes.

For long-only stock market investors, 1250 on the S&P500 should be your line in the sand.  

Avoid complacency: below that level I suggest you consider either selling or hedging however you can.  

Stay tuned...