IT'S NOT CLEAR IF THIS WEEK'S BOUNCE IS THE BEGINNING OF THE END OF THE MARKET CORRECTION OR THE END OF THE BEGINNING OF A BEAR MARKET -- WHY THE CURRENT REBOUND COULD BE PART OF A HEAD AND SHOULDERS TOPPING PATTERN

MARKET BOUNCES OFF IMPORTANT CHART SUPPORT ... Yesterday I showed the S&P 500 bouncing off its March low (after correcting 10%) and also the 400-day moving average (green line) which has ended every downside correction since the bull market started more than four years ago. I also pointed out that the "weekly" stochastic lines had finally reached oversold territory. I concluded that those combined factors suggested that the market fall had been overdone and was due for a rebound. As a result I ended with the opinion that "the worst may be over for now". The fact that yesterday's bounce was led by financials and small caps (which led the market decline) also added to the idea of a bottom. As did the record volume accompanying yesterday's upside turnaround. In an impressive show of good timing, the Fed lowered the discount rate 50 basis points this morning which gave the market an added boost. And, once again, financials led Friday's bounce. Judging from Friday's rebound in global stocks, it looks like investors will go into the weekend in a better mood. Spotting this week's bottom wasn't that hard. The market fell to logical support points and bounced. Now comes the hard part, which is to determine if this week's rebound marks the end of the correction or just the end of the first phase of a larger downturn?

Chart 1

HEAD AND SHOULDERS TOP?... I received a number of e-mails this week asking about a potential "head and shoulders" forming in the S&P 500. The questions could have included the NYSE Composite Index and the Wilshire 5000 Index. All have identical chart patterns. Let's consider the possibility by reviewing some symptoms of that topping pattern. One of the first things to look for in a H&S top is the breaking of an uptrend line. Chart 2 shows that the recent decline broke the uptrend line drawn under the lows of last July and this March. The second requirement is a decline to a previous reaction low (and on rising volume). Chart 2 ahows that happening over the last month. So far, the chart shows a potential "left shoulder" formed in February, a potential "head" formed in July, and a potential "neckline" drawn under the March/August lows. Bear in mind that no H&S top is complete until that neckline is broken. However, the pattern so far suggests the possibility that the current market rebound could be a "right shoulder" in a topping pattern. How can we tell? One way to tell is to watch the broken up trendline (green line). It should now act as a resistance barrier if the market is topping. Another way is to watch the peak formed in February. A "right shoulder" usually peaks around the same level as the "left shoulder". Another way is to use percentage retracement parameters and moving averages.

Chart 2

WHERE'S THE RESISTANCE?... Chart 3 gives a closer look at the potential H&S top in the making. It also suggests where the S&P 500 should run into new selling if it's forming a H&S top. The first possibility is at the top of the February peak at 1461. A second is the 200-day moving average at 1454. The S&P needs to get back above that line (and stay above it) if it's not forming a top. The red horizontal lines show Fibonacci retracement levels measured from the July top to the August bottom. A normal 50% bounce would carry to 1465. To my mind, that puts potential resistance in the 1461 to 1465 region. A close above that range would diminish the chances of a H&S top. A close over its early peak at 1503 would virtually rule it out. Volume will be especially important on this rally attempt. If a real bottom has been seen, volume should pick up as prices rise. If it doesn't, the rally will look a lot less impressive.

Chart 3

BULLISH PERCENT IS IN BEAR MARKET TERRITORY ... A little over a week ago (August 7), I showed the S&P 500 Bullish Percent Index testing major support near the 50 level. [The BPSPX measures the percent of stocks in an index that are in point & figure uptrends]. Readings over 70 indicate an overbought market. Earlier in the summer, I warned that the numbers were starting to turn down from that dangerous level. Readings around 50 separate bull markets from bear markets. The BPSPX climbed over 50 in the spring of 2003 (from oversold territory below 30). Four downside corrections since then (2004, 2005, and 2006) turned up around the 50 level. Not this time. Chart 4 shows the line falling to the lowest level in more than four years. Chart 5 shows the same thing happening to the NYSE Bullish Percent Index. Both of those lines are now in bear market territory. That doesn't mean we're actually in a bear market yet. But it greatly increases the odds that one could be in the making. That also adds more credibility to the view of a "head and shoulders" top formation in the S&P 500 and the NYSE Composite Index.

Chart 4

Chart 5

WHAT CONSTITUTES A BEAR MARKET... Market declines of 3-5% are called "pullbacks". Declines of 10% are considered "corrections". The market has just had its first official correction in more than four years. If the recent lows are broken (like in September or October), that would increase the odds for a bear market. A bear market requires a decline of at least 20%. In a "head and shoulders" top, the downside objective from the "neckline" is the same as the distance from the top of the "head" to the "neckline". Since that distance has been 10% for the S&P 500, any violation of the August low would signal at least another drop of 10%. That would qualify as a bear market. I suspect the recent lows will be retested at some point over the next couple of months. It's extremely important that they hold. Which brings us back to the question in today's headline. Is this week's rebound the "beginning of the end" of the market correction, or the "end of the beginning" of a bear market? I don't know the answer. The best way I know how to find that answer is to follow the charts. We've already learned that we won't get any help from Wall Street or the media.