Long-Term Top Looking More And More Likely

• Several historically reliable indicators are saying “bear”
• World stocks looking extremely toppy
• Shanghai may be forming a head and shoulders top

At my first webinar of the year on Tuesday, it seemed a good idea to load the presentation with some longer-term charts, as they are all pointing to trouble ahead. Incidentally, if you missed the webinar you can watch it here.  I am again going to step back and emphasize long-term aspects in this article because the primary trends they reflect also help determine the characteristics of shorter-term ones. That message came through loud and clear to me later the week. That’s because on Tuesday I pointed out a few clues that pointed to a short-term bottom, such as those shown in Chart 1. These factors suggested to me that the market could well experience a bounce prior to the bearish longer-term forces taking over later in the month. These factors included an exhaustion day in the green ellipse, as well as the fact that it was preceded by a huge downside gap. The horizontal arrows show that gaps are almost always closed or an attempt is made at filling them before prices are free to move in the direction of the gap. The bullish aspect to the chart is that the gap flagged by the red ellipse has now been closed as well as the fact that Monday’s downside gap has yet to be filled. That small rally I was looking for never took place as prices continued to head due south. It’s a great lesson to learn because in bear markets the surprises almost always come on the downside, so what may be a perfectly good bullish technical setup in a rising primary trend completely fails in a bearish one. That’s exactly what happened this week as longer-term bearish forces proved to be the dominant ones.

Chart 1

Long-term indicators

For example, the arrows in Chart 2 show when the 14-month RSI has crossed below its overbought zone on its way back towards zero. As you can see this has almost invariably been associated with a bear market of some kind. The dashed arrows draw our attention to the fact that nothing in technical analysis is perfect, as these signals resulted in false negatives. Incidentally, we are comparing the RSI to the inflation-adjusted S&P Composite, which offers a better interpretation of what is going on over long periods of time than nominal prices. In the latter half of last year we saw another such signal, but this time, the market has yet to drop in a big way. Given the fact that 12 of the 14 previous signals were associated with some kind of a bear market it seems likely that more downside has yet to come.

Chart 2

Chart 3 again features the S&P in deflated format. They say that previous highs and lows represent potential support or resistance zones and in this case, we have three important secular highs as flagged by the thick horizontal trendlines.

The first was in 1929 and on five subsequent periods the small arrows show that this level became an important barrier to five bull or bear markets. In the case of the 1966 peak, we saw six bull markets reversed at this level. As you can see the third line intersects with the 2000 top and has only been challenged once so far. Based on the previous market action, it seems likely that it will need to be challenged several more times before prices are free to move higher.

Something on the downside certainly appears to be in the wind as we can see from the indicator in the bottom window. This one compares the earnings return on equities (Shiller P/E) to the current return on BAA corporate bonds. The chart clearly reflects the long-term swings in this relationship as stocks transition from a position of undervaluation to overvaluation against bonds. The arrows flag periods when the ratio reaches an extreme, or close to it, and crosses below its (red) 12-month MA. In other words, the point when stocks begin to reverse their trend of ever higher valuation against the return on bonds. This approach has failed twice as we can see from the dashed arrows. However, in the vast majority of instances, the signals worked to the extent that three of them represented secular peaks. Since the indicator has again crossed below its MA this approach is warning us that there is much further to go on the downside before this bear has run its course.

Chart 3

Chart 4 compares the inflation adjusted S&P to a 48-month ROC. In this instance, we look to reversals in the 12-month MA of the ROC. There are two levels of signal, those that develop after the ROC has touched or exceeded its overbought zone. These are flagged with the red arrows. Alternatively reversals that have taken place from a more subdued level, but is also above zero, are highlighted with the smaller dashed black arrows. In this case, only two of the seventeen previous signals were not followed or associated with an important decline. Those examples developed in 1926 and more recently in 2013.

Chart 4

Global Equities

Chart 5 shows the MSCI World Stock ETF, the ACWI. This series has been experiencing a negative divergence with its A/D Line for some time but now the price itself looks as if it is completing a major head and shoulders top. We have to be a bit careful here because this is a weekly chart and weekly charts require weekly closes. This one ends on Thursday, January 7, so the “real” plot will only take place on Friday, after what has the potential to be a market mover employment report.

Chart 5

However, when we look at a couple of important international ETF’s more tops appear to be forming.  Chart 6 shows the Spider European 350 (IEV) and Chart 7 the MSCI Emerging Markets ETF (EEM). Again we need to be a bit cautious because both diffusion indicators are at an oversold level. Oversold does not preclude additional weakness by any means, especially in a bear market. However, we would certainly be a lot more confident of the break being a valid one say if the indicator was overbought or even in neutral territory.

Chart 6

Chart 7

Broken China

Chart 8 resurrects another chart from the webinar. This one features the Shanghai Composite ($SSEC). The shaded areas represent bear markets and the arrows show the normal limits of the 13-week ROC in such an environment. Clearly, the ROC behaves differently in a (white) bull market condition to a (shaded) bear trend. Since this indicator is reversing from being close to a maximum bear reading (the thick black line), we should expect additional downside action as the month unfolds.

Chart 8

Finally, Chart 9 shows the weekly close on the Shanghai 300 in closer details. I have put a blue dashed line at the approximate close on Thursday as the StockCharts data base had not upload the close at publication time.  As you can see the price is below its 52-week MA and fast approaching the neckline of a head and shoulders top, which is around 3,000 or 10-minutes of trading at current trading speeds! I am not saying it’s going to go through, but that is very likely given the bear market status of Chinese equities. I am merely suggesting that you watch that level very closely when you grab for your morning coffee. Since China has been leading the world down recently, it continues to have relevance for the US and the rest of the world.

Chart 9

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.