Major Top or Double Bottom?

In a recent late January article,I pointed out that many market averages had fallen to key support levels at a time when a lot of them were experiencing selling climaxes. This kind of condition is usually followed by a rally or basing period, but I also noted that other indexes, including the World Stock ETF, Wilshire 5000 and Russell Small Cap ETF, had already broken to the downside. My conclusion was that "while a relief rally may well develop, now is not the time to be playing hero. Better to take risks at higher levels when the dust has settled."

On Monday, many of those indexes returned to those late January lows. This time, volume is lower, which throws out the possibility that small double bottom formations are being formed. In order to be valid, of course, we would need to see a break above the February retracement high, but the possibility is there.

Chart 1 shows an example using the World Stock ETF (ACWI). The elevated volume bars and PVO indicate the characteristics of a selling climax at the end of January. The low current reading in the PVO shows that the February test is being accompanied by far less activity.  A rally above the February retracement high would complete a double bottom formation.

Charts 2 and 3 show that the stakes are pretty high going forward, as all the market averages are at or have begun to edge bellow key support trendlines that could mark the bases of numerous major top formations. Those that are have already completed a top are currently testing their late January bottoms. The red lines have literally been drawn. Does the double bottom scenario pan out, or is the topping-out process more likely to prevail?

One convincing sign for the double bottom possibility comes from the AAII weekly poll of bullish investors, which has sunk to a level below the green horizontal line in Chart 4. The solid green arrows show that upside reversals from at or below this number have usually marked important buying opportunities as the crowd turns bearish on the market. Two exceptions, in 2008 and 2015, warn us that this is not a perfect approach. It is perhaps no coincidence that both signals were triggered in the early stages of a bear market in the 2008 instance, or a mini-bear in the 2015 example.

Chart 5 puts the current picture in more of a historical perspective, where we can see that the long-term KST is rolling over. It looks as if the S&P has crossed below its 12-month MA, but we need to remember that its not quite the end of the month yet, so it's not yet an official plot. There are two reasons for featuring it. First, it shows that there is a good chance that US equities are in the early stages of some kind of bear market. Second, it illustrates that both of those failed AAII buy signals developed at a similar place in the cycle, i.e. just after a long-term KST peak.

Finally, something else worth monitoring is the ratio between stocks and gold. Usually, when this relationship is in a rising mode favoring stocks, equities rally in their own right, as it means traders are downplaying the safe haven benefits of holding gold. The green shadings in Chart 6, which flag periods when the KST for the ratio is in a rising trend, testify to that. In mid-2021, this relationship broke to the upside, but has since dropped below its breakout trendline and 12-month MA. The KST is still bullish, but may not remain that way for long should the breakout turn out to be a whipsaw.

The unshaded areas on the chart tell us when the KST is declining. These periods are not necessarily bearish for stocks, but, if they are going to experience trouble, these are the kind of conditions under which equities are most vulnerable. Once again, those latest plots are not yet official because the end-of-month data is not available. Please remember you can always update this chart later by simply clicking on it.

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 Groupof Walnut Creek or its affiliates.