Cliff Wachtel's  Instablog

The following is a break from my usual weekly review/preview pieces

Ok, we know things are getting worse before they get better. You’ve heard it before. There’s the global slowdown, the EU crisis threatening to become a global one, etc.

So the big question on everyone’s mind is, how bad can it get? How low will it go?

Conceivably a lot lower than most believe, even if we just look at a few very basic bits of  technical and fundamental evidence.

There are long term technical and fundamental indicators that the current downturn is part of a much longer term move lower. The following is far from a conclusive, thesis. Rather, it’s a starting point for both further study and formation of long term view of where markets are headed.

Chart 1 below shows a nearly 20% drop since recent May 2011(C) high, which has provided a distinct lower high that confirms the bearish double top pattern formed by the highs in 2000 (A) and 2007(B).

Chart 1: S&P 500 MONTHLY CHART  DECEMBER 1999 -  SEPTEMBER 2011  04 oct 08 2054

Points to note:

1. We have additional confirmation of a long term downward momentum from the index having broken below strong support in the 1200-1144 range which included:

• The 50% fib retracement level (not shown in order to keep the chart from being too cluttered)
• The 20 (yellow), 50 (red), 100, (purple) and 200 (pink) month EMAs.

Again, those are MONTHLY EMAs that should provide strong support, and the uptrend on which that Fib retracement was based was formed over 6 years. These are serious long term support levels. Gone.

A valid bearish double top reversal pattern needs to be preceded by a long uptrend.  We’ve got that too.

In Chart 2 below, of the S&P 500 dating back to 1950, we see that long prior uptrend. You could measure it from around, 1990, 1987, or around 1975. The point is, the double top was preceded by a long uptrend, which in turn was part of an even longer term uptrend over the course of the entire period covered.

Chart 2:  S&P 500 04  1950 – 30 SEPTEMBER 2011       oct 06 1637

This 60+ year perspective highlights how prominent the 2000 – 2007 double top is, how clearly it stands out compared to earlier topping patterns.

Here’s the scary part. The general rule of thumb for Head and Shoulders patterns is that the potential pullback is double the distance from the tops to the neckline. The tops (A and B in chart 1) were at about 1500, the neckline was at about 800, a 700 point drop or 46%! Another 700 point drop from that neckline at 800 would bring the S&P 500 to 100, a 93% drop!

Obviously you wouldn’t base your long term portfolio strategy on this one indicator, though.

Still, there is significant fundamental evidence that markets are in a multi-year downtrend. See two of the most popular financial books in recent years:

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DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?