Three Powerful Bearish Signs and How to Profit From the Coming Downturn

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Includes: AUNZ, CEW, DIA, FXA, FXB, FXE, FXEN, FXY, GLD, QQQ, SDS, SPY, TBT, USO, UUP
by: Cliff Wachtel

1. The Down Trend That Began From The Summer of 2008 Peak Has Not Broken-We Remain In a Long Term Bear Market

2. Ominous Death Crosses Spreading Across Major Global Stock Indices-Suggesting Long Term Bear Ahead

a. The Leading Indicator For Risk Appetite, The Shanghai Stock Index, Formed a Bearish ‘Death Cross’ on May 7th

b. The DJ Euro Stoxx50 Followed on May 14th

c. Both The Bellwether S&P 500, Also the Nikkei 225, Are 1-2 Weeks From Their Own Ominous ‘Death Cross’ At Current Rates Of Decline

3. Per Typical Relationships Between Market Bottoms and Moving Averages, The S&P 500 Won’t Bottom Until About 830

The Down Trend That Began From The Summer of 2008 Peak Has Not Broken-We Remain In a Long Term Bear Market

The 5 year weekly chart of the bellwether S&P 500 shows that the long term bear market that began in the Summer of 2008 is alive and well, because the rally from March 2009 – April 2010 only managed a lower high and maintained the overall downtrend from July – August 2008.

The 5 year weekly chart shows the April 2010 peak to be a lower high. Longer term bear is solidly intact. See chart below ().

S&P Weekly Chart For the Past 5 Years 09jun02

For further confirmation that we remain in a long term bear market, note the bearish double top formed on the weekly chart of the S&P 500 from April – August 2000 to July – October of 2008 ().

S&P 500 Weekly Chart Shows Bearish Double Top From 2000 To Summer 2008 At Around 1500 13jun02

Ominous Death Crosses Spreading Across Major Global Stock Indices-Suggesting Long Term Bear Ahead

The ‘death cross’ is a special variation on a type of indicator called a moving average crossover. These kinds of indicators are used as leading and confirming indicators of trend reversals.

Death Cross Explained

A ‘Death Cross’ is when a shorter term moving average crosses below a longer term moving average, and indicates that the ongoing downtrend will be prolonged. Different time frames use different durations for moving averages. In general, the longer moving average should be 3x-4x the duration of the shorter one.

For daily charts, analysts typically use the 50 day exponential moving average as the shorter and 200 day as the longer. These are powerful tools because these are long term moving averages. As a rule, the longer the durations of the moving averages, the more significant the death cross as a sign of more serious downside ahead, because they suggest more entrenched downward momentum.

The Shanghai Index Has Already Formed A Death Cross on May 7th

That’s significant because the Shanghai index is a leading indicator for the S&P 500 and thus risk assets in general.

While the S&P tends to be the best single barometer of risk appetite, the Shanghai Stock Index has led it both down and up over the past 2 years. Note this in the chart below ().

Shanghai Stock Index Vs. S&P 500 (red). 10 june 02

Note how:

  • The red Shanghai line has changed directions first
  • The Shanghai Index has already formed a death cross as of May 7th

The Shanghai’s leading indicator role is already proving itself once gain.

The DJ Euro Stoxx50 Followed on May 14th

Note the daily chart below () of the DJ Euro Stoxx50 shows that it too formed a death cross a week later on May 14th.

DJ Euro Stoxx 50 Daily Chart Courtesy AVAFX 15jun02

Both The Bellwether S&P 500 And The Nikkei 225 Are 1-2 Weeks From Their Own ‘Death Cross’ At Current Rates Of Decline

The S&P 500 appears to be about 1-2 weeks from forming its own death cross at its current rate of descent ().

S&P 500 Daily Chart Courtesy of AVAFX.com 17july02

The same holds true for Japan’s Nikkei 225. Japan is the third largest economy after the US and China.

Nikkei Daily Chart 12june02

Per Typical Relationships Between Market Bottoms and Moving Averages, The S&P 500 Won’t Bottom Until About 830

As reported in businessinsider.com yesterday, David Rosenberg of Gluskin Sheff recently noted:

We went back to the history books and found that at fundamental lows in the S&P 500, whether they be in real bear markets or in severe corrections in a bull market, the index bottoms when it gets 13% below the 50-day moving average and 24% below the 200-day moving average. As of Friday’s close, we are talking about a market that is barely below the 50-day m.a. now and 5% below the 200- day moving averages.

Of course at a longer term market bottom the 50 day moving average is below the 200 day moving average, thus the smaller percentage below it needed to qualify as a likely bottom.

Note the below S&P 500 Daily Chart ():

S&P Daily Chart Courtesy of AVAFX 14jun02

With the 200 day exponential moving average at about 1170, the S&P would need to reach around 830 to meet this rule of thumb. That’s another 22% drop yet to come.

How To Profit

For the rest of the year at least (though there may be some short term bounces late in the summer), we’ve a strong short bias for any trades over a few days’ duration.

In sum, short risk assets like most stocks, commodities, and risk currencies, or short the related ETFs like :

Stocks: SPY,QQQQ, DIA or various ultra-short type EFTs like SDS for the S&P 500.

Commodities: USO (dangerous to short gold as long as worries about the euro remain).

Risk Currencies: FXA FXE FXB BNZ FXEN CEW

Long safe haven assets like US Treasuries and safe haven currencies like the USD and JPY, or their related ETFs: TBT, UUP, and FXY. Note that if worries persist about the euro (very likely over the longer term), gold will likely also rise as a euro hedge.

Longer term buy and hold investors should take at least some profits, especially on stocks that don’t pay dividends, and keep cash ready to go long when the S&P approaches 830.

Disclosure: No Positions