Dark Stormclouds

Dark Stormclouds

Courtesy of Springheel Jack of Channels and Patterns

The week ended ambiguously, with a deep retest of the Inverse Head and Shoulders (IHS) neckline on the S&P 500 (SPX) on Thursday. The SPX overshot the neckline by ten points, and then bounced back to close at the neckline on Friday. If SPX recovers and holds over the neckline, it would be a bullish setup with a target slightly over 1400:

Generally, at this stage in a US presidential election year, we would see a strong rally into the election that would take equities to new (post-2009) highs.

However, this is not a normal election year. Large storm clouds are looming over equities. The setup is potentially very bearish on many world indices. The MSWorld index, which includes all main world indices excluding the US, shows a declining channel from the 2011 high. A huge bearish head and shoulders pattern has formed over the last three years with a target in the 850 area, on a break below the current 2012 low – around 40% below Friday’s close and 7% below the 2009 low:

Is there any support for this very grim scenario elsewhere? Yes, there are significant reversal patterns in copper, oil, and other instruments that are normally correlated with equities.

One of the most striking reversals is with the US Dollar, which often rises as equities fall. There is an Inverted Head and Shoulders pattern on the Dollar, with a target at 90.5, well over the last USD high made as equities were falling in 2010. This would be a negative backdrop for equities if it plays out as it typically would:

This is part of a much larger bullish picture on the US Dollar suggesting a move to 105 on a break over 89. The chart below shows the shifting correlation over the years between USD and equities, with the usual inverse correlation for most of the period since 1980, but with two periods of positive correlation 1980-5 and 1995-2000. You can read more about this correlation and the bigger picture on USD in a post I wrote in mid-April here.

The open and ongoing support for the US stock markets by the Fed since 2009 is not a sign of underlying good health. The MSWorld index also gives an insight into what US markets might look like in the absence of the Fed’s support. These huge bearish patterns are a clear warning to be nervous about investing in equities at this time.

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