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Very Bearish Intermediate Term Technicals Indicated in the Markets


 6:15 p.m. on Saturday, June 5, 2010. Publication times vary from one publication to another and this article may or may not be dated depending on when or where it is read. The author holds no position in the equity markets.

I have become gravely concerned with the intermediate to long term technicals in the equity markets as a very bearish 10-month technical formation has now formed on every major index in the U.S. stock market. The DJIAS&P500NASDAQ, and QQQQ have all formed a 10-month Ascending Broadening Wedge which according to Cobra's Market View is backtested as being bearish nearly 80% of the time. And the longer it continues the more bearish it becomes and the more likely this particular wedge falls within that 80% range (meaning the chances increase). At the current moment, the DJIA and S&P 500 both closed exactly at their lower wedge lines. The NASDAQ and QQQQs recently bounced off of this wedge line and are now headed right back towards it.
To give you a little background about why an Ascending Broadening Wedge is inherently bearish and how it forms to begin with I offer the following. In a normal up or down trend, you have two lines that can be drawn to form a channel. The market direction is indicated by whether the channel is upward or downward. Since the end of April for example, we've been in a short-term normal downward channel trend and the markets have traded quite normally within the lower and upper downward trend-line boundaries. We bounce off the lower trend line and get resistance at the upper trend line. A break of the lower trend line will lead to capitulatory selling, while a break of the upper trend line will lead to a new up-trend. That's how normal markets should act. In a downward channel, the supply of sellers only slightly out-strips the demand of buyers and that's how the downtrend is created.
Other times you get a convergence of the upper and lower trend lines which is also quite normal in markets. When the two lines converge upon each other in a downtrend its called a descending or falling wedge and almost always leads to bullish trend reversals. It literally means that the supply of sellers is falling while the supply of buyers is increasing throughout the entire trend. The opposite is the case in a rising or ascending wedge.
Yet, in some rare occasions you get a situation, like we have here, where the lower and upper trend lines diverge - move away from each other in opposite directions. In these rare cases, what happens is that in order to get to the lower trend line, the selling has to be much stronger than in the previous leg down and the rallies have to be significantly more robust just to get back up to the upper trend line. This trend is entirely unsustainable because eventually you get to the point where the market has to rally 200% and fall 80% just to stay within its trend lines. Eventually Ascending Broadening Wedges have to unravel. And the longer it takes for them to unravel the more severe the sell-off. Usually, the textbook target in ascending broadening wedges is a 100% retracement of the entire move bringing us back to where the trend began.
So lets exam the current Ascending Broadening Wedge on the S&P 500 (click here for the annotated chart), though this applies to the other major indices as the same formation has been created on the other major indices and ETFs as well. This wedge all started in September 2009. We got a relatively robust rally that brought us to 1080 on the S&P 500. In mid-September we then got a minor correction to the 1020 level - a 5.6% correction. From there we then got a rally to the 1100 level (7.8% rally) in October which was followed by a 6.3% correction to the 1030 level. Notice already, that the correction in November brought us basically back to the October lows which is very characteristic of a broadening wedge. Now to make a new high, we have to get a more powerful rally especially if the markets are to maintain the upper trend line. And in fact a significantly more powerful rally ensued. From the November correction we rallied all the way to 1150 on the S&P which took us exactly to the upper wedge line. That was an 11.6% rally between November to mid-January.
Notice how the moves are getting larger and larger each time we make a distinct move in the markets and how unsustainable this behavior will soon become. What happens next will start to clearly define this broadening rising wedge. Instead of a getting a mild correction that will make this whole move more sustainable, we get a correction almost all the way back down to the November lows or 1045 on the S&P 500 (only 15 points above the November low). That was exactly a 10% correction from January highs to February lows.
At this point to sustain the Ascending Wedge (and I must say that I didn't believe we had the buying power to get there) we had to have one of the most overbought conditions in the market's history. Every single technical indicator suggested that markets would crash by late April as the markets rallied from its lower wedge line of 1045 all the way up to 1230 on the S&P 500. On the 7-Day RSI, we only saw a few other instances in history where the S&P saw well over 90. The call-to-put ratio on the ISEE indicated that April 15 was one of the most bullish days in modern U.S. history in terms of sentiment based on the call-put ratio on the CBOE. Almost everyone was long and unhedged and on the bullish side of things. Thus, from the February lows of 1045 we rallied to 1220 on S&P500 in a little over two months time. That's a 17% move in the markets a very short period. We had only a handful of down days in over 75 trading sessions. That set a new record for the number of up days without a 1% down move in the markets.
But what was even more concerning in late April is the down move that would have to ensue in order to sustain this wedge - the wedge line is sitting at about 1065 on the S&P500 and was sitting around 1050 in late April. That's a 14.5% correction that would be needed to sustain the wedge. And that is exactly what we got. The last two moves in the market caught the attention of the entire world. I fear that the next two moves in the market will have devastating consequences if this Broadening Wedge does not unravel in this correction. Its much better to have it unravel here, then to rally to 1350 on the S&P500 only to see a catastrophic sell-off to the 1000 level.
For the S&P 500 the textbook target will bring us back to 1010 which will be a 100% retracement from the entire broadening wedge. From there the markets can go back to the drawing board and create a new more sustainable up or down trend. Yet, if the market rallies from here (and evidence is mounting that we might have a summer rally) and we find ourselves cheering that we hit 1320-1350 on the S&P in late September, I will be busy shorting the hell out of the market. Because from there, the target price is still 1010 - a 100% retracement of the entire broadening wedge.
The DJIANASDAQ and QQQQ have also formed the same Ascending Broadening Wedge pattern as seen in the S&P 500. The lower wedge line for the DJIA is sitting at 10,o00 and the textbook target for a full retracement of the wedge is at 9400. For the NASDAQ, the lower wedge line sits just right above 2175 and the textbook target is at 2025 for a full retracement. While the QQQQ lower wedge line sits at about $43.50 with a full retracement at the $40.00 level.
Regarding Apple
As Apple heads into the WWDC next week, we saw a relatively significant sell-off in the name due to broader market concerns. Yet, if we see continued selling pressure into next week from the markets, I fear that unless Apple wows the public with its new iPhone, we might get some major sell on the news as we have the previous two times Apple released an iPhone. Its not uncharacteristic to see some selling pressure in Apple until mid-to-late July when the fall tech rally kicks off with earnings. How Apple trades next week will be very crucial in judging its direction over the next few weeks. Personally, I would be far more interested in the name if it pulled back after going from $78 to $271. A pullback to $200 would be an outstanding opportunity. Though higher than expected resilience in the stock in the midst of this correction indicates that this possibility is growing increasingly unlikely. I'm looking to buy the stock when I feel more comfortable that broader market concerns are behind us.
Regarding Goldman Sachs
I would start to become interested in owning this name if and only if we get a double bottom after some major selling pressure in a second leg down. If GS can pull back to $135, rebound and then break $145, I would be a buyer of the stock.
Regarding Amazon
What is there to say about AMZN that hasn't already been said about the housing market in 2005. When will these morons figure out that AMZN's 55 P/E is entirely unwarranted. This stock needs to follow in RIMM's footsteps. I'm not going to pay a 55 multiple for AMZN if I can pay a 15-20 multiple in AAPL which incidentally grows just as fast as AMZN but with significantly more profits.
Regarding Google: 
Google is too rich for me. Get this thing down to $420, form that beastly head and shoulders and I might take a bite. For now I'm not happy at this level.

Disclosure: At the time of this writing (Saturday, June 5, 2010 6:15 pm), the author holds no position in the equity markets though continues to explore taking both long and/or short position at any time. The information contained in this blog is not to be taken as either an investment or trading recommendation, and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts express in this publication.