July 8th, 2008

The bottoms for .SPX, .RUT, .DJI and .IXIC

I don’t often look at different slices of the market because I use the S&P 500 as my performance benchmark but walking around the situation and seeing it from different vantages can often shed light and bring into clearer focus where the opportunity and risks are.

A trendlines isn’t real; it’s merely extrapolation of potential future pivot points, or points out in the future where the equilibrium between buyers and selllers could potentially flip. A trends momentum will tend to continue if equilibrium doesn’t turn at a pivot point until the price meets another trendline and potential pivot point in the future. There are no pivot points only when a stock or index is forging ahead in new all-time high territory.

Extrapolating trendlines is highly subjective and literally an infinite number of trendlines could potential be drawn on any graph. But what tends to narrow the range of possibilities is when many stocks in an industry or indexes of different subsets of stocks all show similar charts. These stock charts are subject to two basic premises:

  • the “50% rule” stating that a trendline or a consolidation pattern represents the midpoint in a stock or indexes total move. Therefore, in the following charts, I estimated the that move beyond the neckline will equal the move leading up to the neckline.
  • the “confimation rule” stating that after a trendline/neckline has been broken, the stock or index will look for confirmation by either returning back to the trendline/neckline or vascilate in a small pattern touching the trendline.

Here are the four major market indexes and what appears to be head-and-shoulders top patterns in each and the target bottom implied by each:

  • .SPX (S&P 500): Famously, now, the Index failed in 2007 to breach the long-term trendline extended from the 2000 all-time high. But the movement of the Index since the beginning of 2006 resembles a head-and-shoulder top formation. Using the 50% move points to a possible bottom at around 1027, or 18% below current levels. The confirmation pattern may form above 1150 (the level that happened to be the neckline of a head-and-shoulder bottom formed in 2001-04).

  • .RSX (Russell 2000): surpassed it’s 2000 peak and has formed a head-and-shoulder top with a downward sloping neckline. The 50% rule would place a target for the bottom at around 482, or 27% below current levels.

  • .DJI (Dow Jones 30 Industrials): Also surpassed the 2000 peak high. This index has already broken through both the neckline of its head-and-shoulders pattern, as well as moving below the trendline extended from the 2000 peak. The 50% rule puts a target for the bottom at 9460, or 16% below current levels.

  • .NDQ (Nasdaq): Has failed to fully recover from the bursting of the tech bubble in 2000-03 and is still 56% below the peak of 5132. This index is giving less clear signals about its future direction. Although no traditional topping pattern has emerged (although an inverted triangle is usually a bearish indicator), it is clear that the index has broken through the bottom boundary of the upward sloping channel it’s been climbing since 2004. An interim consolidation is possible at 2080 (the pivot point in 2006) with the bottom forming between 1646 and 1750.

Clearly, this is all highly subjective but it does provide a base case for expectations. Heavy buying shouldn’t commence until and unless some external events cause a deviation from these projections.

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