U.S. STOCK INDEXES THREATEN 2015 LOWS -- WHAT HAPPENS IF THEY DON'T HOLD -- THE S&P 500 COULD LOSE ANOTHER 10-12% AND DROP TOWARD 1600 -- NYSE ADVANCE DECLINE LINE TURNS DOWN -- INDEX OF FOREIGN STOCKS IS IN BEAR MARKET

U.S. STOCK INDEXES THREATEN 2015 LOWS ... Another week of heavy selling has pushed major U.S. stock indexes into a critical test of their 2015 lows. The first three charts tell the story. Chart 1 shows the Dow Industrials ending the week just above its late September intra-day low at 15942. Chart 2 shows the Nasdaq Composite threatening its late September low at 4487. And Chart 3 shows the S&P 500 threatening August/September lows from 1867 to 1871. So far this month, the Dow and S&P 500 have lost -8%, while the Nasdaq has lost 10%. All three indexes are in correction territory which means they've lost more than -10% from last year's highs. Small cap and transportation stocks are already in bear markets with losses in excess of 20%. That doesn't bode well for the market as a whole. Which raises the bigger question of what happens if 2015 lows don't hold.

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Chart 1

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Chart 2

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Chart 3

POSSIBLE HEAD AND SHOULDERS TOP ... I'm going to focus on the S&P 500 since it's the benchmark for the U.S. stock market. Chart 4 shows the price formation for the SPX since late 2014 having the look of a potential "head and shoulders" topping pattern. A H&S pattern has three prominent peaks (circles) with the middle peak (the head) higher than the two surrounding "shoulders". A "neckline" is a trendline drawn under the October 2014 and August 2015 lows. A decisive violation of 2015 lows would push the SPX well below the neckline and signal a much bigger decline. That type of breakdown would also result in a bearish pattern of "lower peaks and lower troughs" which is the standard definition of a downtrend. The next downside target would be its October 2014 low at 1820, but lower lows are likely. To measure the potential downside target from a H&S top, the size of the decline from the top of the head to the neckline is subtracted from the point where the neckline is broken. That would yield a potential downside target to 1600.

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Chart 4

A LONGER RANGE PERSPECTIVE... The weekly bars in Chart 5 shows the four-year rally in the S&P 500 that started in October 2011. The Fibonacci retracement lines, which can prove helpful in determining potential downside targets, are measured from the 2011 low to the 2015 high. The three lines show that a drop to 1600 (the measurement from the potential H&S top) would represent a 50% retracement of the four year rally. The S&P has already lost more than -12% from its 2015 high. That suggests that another 10%-12% drop from current levels is possible.

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Chart 5

MONTHLY CHART SHOWS MAJOR SUPPORT NEAR 1600... The monthly bars in Chart 6 put the bull market since 2009 in better perspective. And it also carries the threat of a drop toward 1600. For one thing, the 14-month RSI line (top of chart) in in danger of slipping below its midline at 50 which would signal a deeper correction. For another, its monthly MACD lines (below chart) are negative. That's a serious warning sign that the market uptrend is in trouble and in need of correction. Chart 6 also shows that the two prior bull market peaks in 2000 and 2007 took place just below the 1600 level. That adds more credibility to 1600 as a potential downside target and, hopefully, a major support level. [A drop to 1600 would also constitute a 38% retracement of the 2009 - 2015 uptrend].

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Chart 6

ADVANCE-DECLINE LINE TURNS DOWN... Some of us have been warning about the fact that the fourth quarter rally was mainly driven by large cap stocks and wasn't being supported by the vast majority of stocks. That's been shown by breakdowns in small and midsize stocks and the fact that 80% of big board stocks have fallen below their 200-day averages. The best known measure of market breadth is the NYSE Advance-Decline line. Chart 7 shows that line falling well short of its 2015 high during the fourth quarter, which was an early warning. This week's drop below its August/September lows to a 52-week low is another. That puts the AD line in its first downtrend since the bull market started seven years ago. That's a bad sign for the stock market.

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Chart 7

FOREIGN STOCKS ALREADY IN BEAR MARKET ... The concept of "market breadth" also applies to global stocks. In a healthy uptrend, most stocks markets should be rising. When most are falling, that 's bad for everyone. I've been pointing out the fact that foreign shares have been much weaker than the U.S. and have already started to break down. That's not good for them or us. The weekly bars in Chart 8 show the Vanguard FTSE All-World ex-US ETF (VEU) falling to a three-year low after having completed a "double top" reversal pattern (see circles). The VEU has lost -22% since last spring and is in a bear market. That includes developed and emerging markets. EAFE iShares (which measure foreign developed markets) has fallen to a two-year low, while Emerging Markets iShares are trading at the lowest level since 2009. It's pretty tough for the U.S. to hold up when the rest of the world is in a downtrend. Global stocks also become more highly correlated during downtrends. That increases the odds that we've started to follow them lower.

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Chart 8

BOTTOM LINE... With foreign stocks in a bear market, U.S. stocks are in danger of following suit. Internal market measures show that the market is already much weaker than the major stock indexes. That also increases the odds that 2015 lows will be broken. If that happens, the S&P 500 could lose another 10-12% before reaching major support. Sector rotations also show that investors have been rotating toward defensive consumer staples and utilities, and have been selling economically-sensitive stocks. Commodity-related stocks are still being sold hard. Countries tied to commodities are being hit especially hard, as are their currencies. Chinese stocks and the yuan are sinking together. The dollar and yen are the only two currencies holding up. A firm dollar is keeping downside pressure on commodities. Money leaving stocks is moving into the safety of Treasury bonds and gold (not to mention cash). That's what normally happens in times of financial stress. Economists are starting to worry about the health of the U.S. economy. Stock selling suggests investors are worried too. On a lighter note, enjoy the three-day weekend. We can all use a timeout.