Do Recent Losses Signal End of the Bull Market?

The Dow Jones Industrial Average finally notched a new intraday high last week, but by Friday's close the air had seeped out of the party balloons and the entire market reversed course to the downside.

While the Dow and Standard & Poor's 500 have yet to break major supports, trendlines or moving averages, the writing is on the wall. It seems to be just a matter of time.

It is tempting to say that the Nasdaq suddenly fell apart and that dragged the rest of the market lower. The Nasdaq, however, peaked March 6 and has been in a down trend for more than a month already. Some of its highest flyers, such as Amazon.com (ticker: AMZN), which peaked in January, are already down more than 20%. That's a bear market in the textbook.

As for the S&P 500, last week saw a move above the top of a six-week trading range (see Chart 1). Bulls rejoiced, as it seemed that the index was finally back in gear and ready for further gains.

Chart 1

STANDARD & POOR'S 500

But there was something fishy about the breakout. For starters, the index ran from the bottom of the trading range to and through the top without pausing, and that is often a momentum-based overshoot of resistance. Meaningful breakouts usually are a bit more explosive – a sudden burst from a period of calm.

Pundits touted the presumed breakout, but other indexes – the Dow, the Russell 2000, the Nasdaq and the broad-based Value Line and Wilshire 5000 indexes – failed to confirm the move. Technical analysts call that "non-confirmation" and it told us that the soldiers did not follow the generals. Armies cannot win wars without soldiers.

Friday, the market's initial reaction to a modest but positive employment report was to the upside. Before lunch, however, stocks turned lower, led by Internet, social media and biotech names. These former momentum leaders were already in retreat when Friday's decline confirmed short-term down trends all around.

Technical analysts point out that Friday's initial rally and close below the previous day's low left a bearish "outside-day" on the charts. Its significance is a sudden and dramatic change from bullishness to bearishness, and if there is downside follow-through it can also signal a top. That follow through seems to have begun Monday.

But there is more to the sell-off. Failed upside breakouts through trading range, as seen in the S&P 500, often become bearish signals by themselves. At a minimum, they suggest a move to the bottom of the previous pattern. If that fails to support, the market then it will have even more trouble ahead.

As mentioned, the Dow Industrials reached a new high last week (see Chart 2). That prompted followers of Dow Theory, the century old method of chart analysis that in part watches the Industrials and Transports together, to rejoice. In simple terms, new highs on both indexes create a buy signal.

Chart 2

DOW JONES INDUSTRIAL AVERAGE

The Transports were already at new highs, so the Industrials breakout was supposed to be bullish. The problem was that the Industrials never closed at a new high. The anticipation, if not euphoria, surrounding the signal suggested excessive optimism, even if that was not reflected in traditional sentiment indicators such as the CBOE volatility Index (VIX).

That leaves the Dow with a failure at resistance and that leans bearish. If the index falls below last month's low of 16,047, then the bearish signal would be confirmed.

Finally, the Nasdaq is in the worst shape of the three major indexes and is the only one below its 50-day average (see Chart 3).

Chart 3

NASDAQ

The critical event was the drop below the trendline drawn from the June of last year. That low point was a key inflection for the market as it ended a one-month slide that had created a rather fearful atmosphere. The sudden upside reversal left an important anchor point on the charts that technical analysts have used ever since.

When a key trendline breaks we have to take notice. The Nasdaq is now broken and favorite momentum stocks are toast.

The Dow and S&P 500 are damaged but not yet officially broken. Therefore, there is still hope for the bulls. But backstage I can hear the fat lady warming up.

Getting Technical Mailbag:Send your questions on technical analysis to us atonline.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.

Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.

Comments? E-mail us at online.editors@barrons.com

Source:

www.macworld.com