COMMON CHARACTERISTICS OF MARKET TOPS -- RSI MOVES INTO BEAR MODE FOR THE S&P 500 -- CONSUMER DISCRETIONARY MOVES FROM LEADER TO LAGGARD -- STEEL AND HOMEBUILDERS LEAD KEY INDUSTRY GROUPS LOWER -- EUROPEAN BANKS LEAD EUROPEAN INDICES LOWER
COMMON CHARACTERISTICS OF PRIOR MARKET TOPS... Link for todays video. Now is a good time to review the prior market reversals for clues on what to expect with this reversal. History does not repeat itself, but it sure does rhyme (Mark Twain). The current bearish reversal in the S&P 500 is the third major reversal since 2000. Chart 1 shows a topping pattern and reversal in 2000-2001. Chart 2 shows a Double Top and reversal in 2007-2008. These two reversals share many common characteristics.
* Both reversals involved a long topping process (9 months)
* This topping process established clear support levels
* Both breakdowns occurred with decisive declines
* RSI broke below 40 to confirm the trend reversal
* Sharp throwback rallies retraced just over 50%
* Broken support levels turned into resistance

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Chart 1

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Chart 2
RSI MOVES INTO BEAR MODE FOR THE S&P 500... The current market reversal shares some of the characteristics listed above. Chart 3 shows weekly candlestick for the S&P 500 over the last two years. First, there was a clear topping process as the S&P 500 traded flat for seven months. Even though the timeframe is shorter and the high-low range is smaller than in prior tops, there is a clear Head-and-Shoulders pattern. Second, there is a clear support break. Third, there was a decisive decline to mark this trend reversal. Fourth, RSI broke below 40 to turn long-term momentum bearish. The 50-60 zone now becomes resistance.

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Chart 3
At this stage, it is unclear when we will see an oversold bounce that retraces a portion of the current decline. The current decline is a mere seven weeks old, but has already lopped off 18.9% (July high to August low). The 2000 and 2007 bounces lasted 9-10 weeks. However, the prior declines were 23 and 29 weeks, respectively. This means it could be several weeks before we see a decent oversold bounce. The 2010 lows mark the next support zone around 1050. A move to this level would entail a 300 point decline (1350 to 1050 or 22%). A 50% retracement of this decline would carry the index back to 1200, a level seen earlier this week.
CONSUMER DISCRETIONARY SECTOR MOVES FROM LEADER TO LAGGARD... Selling pressure over the last 31 days pushed the Consumer Discretionary SPDR (XLY) from a market leader to a market laggard. PerfChart 4 shows 31-day performance for the nine sector SPDRs relative to the S&P 500. I chose 31 days because this extends back to July 7th, which is when SPY peaked. My goal was to find sectors showing relative strength and relative weakness during the most recent decline. The percentage change shown is the relative change, which equals the percent change in SPDR less the percent change in SPY. Sectors with positive bars are outperforming SPY (up more or down less), while sectors with negative bars are underperforming SPY (up less or down more). This PerfChart shows a clear preference for the defensive sectors. Notice that the Consumer Staples SPDR (XLP), Healthcare SPDR (XLV) and Utilities SPDR (XLU) are outperforming SPY. Even though they are down on an absolute basis, they are down less than SPY and up on a relative basis. The Technology ETF (XLK) is also outperforming SPY, but its relative strength is overshadowed by relative weakness in other key sectors.

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Chart 4
The Finance SPDR (XLF), Industrials SPDR (XLI) and Basic Materials SPDR (XLB) are the weakest sectors. Relative weakness in finance remains a major concern for the broader market. The Consumer Discretionary SPDR (XLY) is a relatively new addition to the relative weakness list. A month ago, this sector was one of the best performers (on a relative basis). It has now moved into the negative column for relative performance. This is a big concern because the consumer discretionary sector is the most economically sensitive sector. Key industry groups in this sector include retailers, restaurants, homebuilders, airlines and manufacturing.
STEEL AND HOMEBUILDERS LEAD KEY INDUSTRY GROUP ETFS LOWER... PerfChart 5 compares the performance of nine key industry group ETFs to SPY over the last 31 days. These are offensive industry groups that lead higher in bull markets and lower in bear markets. All nine show relative weakness with losses greater than SPY. This is clearly a bear market type performance chart. In particular, the Steel ETF (SLX) and the Homebuilders SPDR (XHB) show the most relative weakness. Steel goes right to the heart of big industry (concrete reinforcement, autos, appliances, railroads, buildings, wiring).

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Chart 5
Relative weakness in the Retail SPDR (XRT) is, however, the biggest concern here. Like the Consumer Discretionary SPDR, the Retail SPDR was showing relative strength just a month ago. In fact, retail was one of the top performing industry groups in early-mid July. With retail spending driving some 2/3 of GDP, this abrupt switch from relative strength to relative weakness is bearish for the economy, and the stock market. At the very least, a sharp decline in the stock market will likely weigh on consumer sentiment and spending in the coming weeks and months.
EUROPEAN BANKS LEAD EUROPEAN INDICES LOWER... John Murphy showed the German DAX Index ($DAX) moving sharply lower on Thursday and this index continued its slide on Friday. Chart 6 shows the DAX moving below last weeks low and hitting a fresh 52-week low this week. New lows occur in long-term downtrends, not uptrends. Chart 7 shows the French CAC Index ($CAC) moving sharply lower the last two days. This index hit a new 52-week low in early August. Chart 8 shows the London FTSE 100 ($FTSE) breaking support and hitting a new low in early August.

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Chart 6

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Chart 7

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Chart 8
As in the US, the European finance sector and the big banks are the poorest performers. It is hard to imagine a turnaround in Europe without a turnaround in the banking stocks. Chart 9 shows BNP Paribas (BNP.EU), a big French bank, breaking support in mid July and plunging to new lows in August. Chart 10 shows Deutsche Bank (DBK.DE), a big German Bank, peaking in February and breaking support in July-August. Chart 11 shows Lloyds Group (LLOY.L), a UK bank, with a downtrend that simply accelerated as the year wore on. All three charts are representative of the European banking woes. Charts for stocks on the Deutsche Bourse, EuroNext Exchange and London Stock Exchange are available to StockCharts.com subscribers. See this mailbag article for more details.

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Chart 9

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Chart 10
