A Crack in the Dike

November 13th, 2013
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By early March 2009, the Dow Industrials had declined to 6469.95 from its (then) all-time High of 14198.10 in October 2007, a loss of 54%. Stock portfolios had been devastated. Almost everyone believed that the stock market would continue to fall. Even the leading lights of industry predicted a further decline, as well as the "death of the dollar." There were only a few who proclaimed that a major Low was near, and that a resurgence of the market was bound to follow.

Follow up:

It was the few who were correct. The Dow bottomed in early March 2009; and the upswing which followed has become the Great Rally - the most astounding countertrend rally of all time. We had thought, several times, that it was coming to an end; but each time we were mistaken. Now, however, we have reason to believe that the rally is breathing its last. By several measurements, investor confidence in a continuation of the market's rise is extraordinarily high. Complacency rules the market; fear is almost totally absent. "Breadth" is narrow. Minor rallies are caused by a rush to buy in only a few select equities.

The October 30 all-time High in the S&P 500 was marked by the appearance of a classic Candlestick reversal pattern. A larger multi-bar pattern appeared on November 7. In each case, the S&P fell off materially after the patterns appeared, to a Low of 1746.20 on November 7. From that point, the S&P advanced rapidly on November 8, but came to a halt and traded horizontally on November 11. The aggregate sentiment of the traders appeared to one of "indecision." Our Indicators were not at extremes; so it was difficult, if not impossible, to forecast which way the S&P would move.

The price action in the S&P so far today may offer a clue. We see a "Tower" formation in the 60-minute chart, in which the flat trading of November 11 has been bracketed by a tall white Candle which appeared on November 8 (a Friday) and by a tall black Candle which appeared yesterday, November 12. We take the "Tower" pattern as bearish in tone.

While this is hardly definitive, it is at least a clue. The formation may be obviated by a price rise which totally overtakes it.

We take the pattern for what it is - a warning.

It would be vindicated by a decline in the S&P to a point below 1746.20, which was its Low on November 7. A drop below that Low, together with a concomitant dtop in the Dow Industrials, would strongly suggest that the Great Rally is finally over and that a powerful market decline is on the way.

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