U.S. STOCK INDEXES THREATEN 200-DAY LINES -- FOREIGN STOCK INDEXES HAVE ALREADY BROKEN THEIRS AND MAY BE TRACING OUT HEAD AND SHOULDERS TOPS -- TEST OF 2011 LOWS WILL BE CRUCIAL
S&P 500 NEARS TEST OF 200-DAY AVERAGE... The slide in stocks continued this week to the point that some key support levels are about to be tested. Chart 1 shows the S&P 500 bearing down on its October high (1292) and its 200-day moving average (red arrow). A decisive close below both of those potential support lines would signal a much deeper slide in U.S. stocks. Unfortunately, a couple of U.S. stock indexes have already fallen below their 200-day line. Chart 2 shows the NYSE Composite Index ending the week at a new 2012 low. It's also well below its October peak and 200-day line. That's a negative sign. So is similar chart action in the Russell 2000 Small Cap Index as shown in Chart 3. Those two breakdowns suggest that the current stock decline may be more than just a normal correction. So does the even weaker action in foreign stocks.
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Chart 1
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Chart 2
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Chart 3
FOREIGN HEAD AND SHOULDER TOPS?... What really worries me about the direction of stocks is the possibility that foreign stock indexes could be tracing out two-year "head and shoulder" tops. That's true of both developed and emerging markets. Chart 4 shows EAFE iShares tracing out a textbook "H&S" top. [A head and shoulders top is identified by three peaks with the middle peak (the "head") higher than the two surrounding "shoulders"]. The fact that the two shoulders are about the same height adds to the symmetry of the pattern. The "neckline" is the trendline drawn under the 2010-2011 lows. A decisive violation of that support line is a very bearish sign. It now looks like the EAFE will retest that trendline (or its late 2011 low). That will a very important test, and hopefully will produce an oversold bounce of some type. Chartwatchers know, however, that the overall shape of the potential topping pattern since the start of 2010 calls for a lot more caution. The same is true of Emerging Market iShares in Chart 5. If those the late 2011 lows are broken, that would be a very bearish sign for global stocks. Given the tight correlation among global stocks, any breakdowns in foreign stocks would have a negative impact on U.S. stocks as well.
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Chart 4
