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2nd great depression, Michael Nystrom, editor, www.depression2.tv
Professional investors know, both in their hearts and in their minds, that markets know things. Markets reflect, as we have said and will say again, the collective consciousness of both astute professional investors and their sometimes less sophisticated counterparts, individual investors. The prices of stocks, bonds and commodities, as academics will point out, reflect all that can be known about the future with any degree of certainty at a particular point in time.

- Ron Insana, The Message of the Markets*
Something Big in the Offing
SEATTLE - 10 June 2002 - by M.A. Nystrom
Markets are intelligent, if for no other reason than because all of the participants are collectively smarter than any one individually. In the marketplace, the votes of the individual bulls and bears are cast with dollars. Those standing on the sidelines cast their votes with skeptical silence, and their lack of conviction makes itself evident in the daily volume figures. Over time, price and volume figures reveal patterns of behavior created by the market participants. It has long been said that these patterns have predictive power, since the patterns of behavior reveal the moods and thought processes of the all the market players. This, of course, is the basis for technical analysis of stock trends.

In examining the behavior of the S&P 500 leading up to the terrorist attacks of 9/11, (Chart 1), certain curious activity can be observed. The SPX had been in a slow, meandering decline for almost three months prior to the attacks of 9/11. From its peak in May 2001 until the beginning of August, the SPX lost about 7.6%. Upon entering August, the decline accelerated, with the market losing 8.3% from the beginning of August until September 10th. The next day, of course, came the attacks. With the resumption of trading a week later, the market shed 13.6% in a quick five trading days before bottoming.

SPX Last Year
Chart 1

The question at hand is - did the market correctly anticipate, or "discount" the catastrophe, or was it merely a coincidence that the attacks came during a period of accelerating decline? This is a philosophical question which is difficult to answer definitively. But thinking about it can give us additional clues and insight into the behavior of markets, and what the market may be telling us today.

In looking at the September 2001 activity, we see that the market broke long-term support at 1,100 just two trading days prior to the attacks. In fact, September 10th saw the market rally back to the underside of 1100, ready to challenge this newly created resistance level which only days before had served as long-term support. The terrorist attacks made this challenge to the resistance level moot, and several trading days were wiped off of the chart. When trading resumed 4 days later, the question as to whether 1100 would serve as support or resistance had already been answered.

This examination of last September's activity leads us to the more pressing issue of what the market is telling us today (Chart 2). Like last September, the market is in a state of protracted, if not un-dramatic decline. The SPX is down about 10% since its last intermediate peak in March, but recently the decline has been accelerating. Like in September, the market is flirting with a long-term support/resistance level, this time 50 points, at 1050. At the time of this writing, the market is below the line, struggling to get back up to it. In other words, it is at a parallel point to the last terror attack.

SPX Current
Chart 2

What makes this all the more interesting is the huge, 5 year long head and shoulders pattern which is nearing completion in the SPX (Chart 3).

SPX 5 year
Chart 3

The head and Shoulders pattern, according to Edwards & Magee, in their seminal work The Technical Analysis of Stock Trends is "one of the more common, and by all odds, the most reliable of the major reversal patterns." (p.64). It is a sign that the rally is done, the topping process is complete, and declines are to begin in earnest.

The head and shoulders pattern also features measuring implications. According to Edwards and Magee: "Measure the number of points down vertically from the top of the head to the neckline as drawn on the chart. Then measure the same distance down from the neckline at the point where prices finally penetrated it following the completing of the right shoulder. The price level thus marked is the minimum probable objective of the decline."

For a pattern of this magnitude, the downside implication for the SPX is somewhere around 400! Once the neckline is broken, the decline can be quite dramatic, as pictured in this chart, from Edwards & Magee of Union Carbide during the 1929 crash.

I am well aware that I am not the first identify the giant H&S pattern in the SPX, and certainly won't be the last to talk about it. There is a principle about markets that says if too many people have the exact same information, none of them will profit from it. That being said, is it possible to have a reversal of this magnitude when everyone and his brother can see it as clear as day? Maybe. Maybe not. There is no doubt that these are strange times we are living in.

We are quickly approaching a point of many intersecting convergences in the stock market. Major support at 1050 on the SPX has just been broken. Last week was the third down week for all the major market indices, all of which broke to new yearly lows. The decline last week was particularly strong, with the SPX pushing down hard toward the neckline of the H&S pattern, implying an explosive break in the next several weeks.

Like the September 2001 break, the upcoming break being forecast in the charts may be accompanied by a dramatic external event. To the lay observer it may appear that the external event "caused" the market drop. In fact, it is not a cause-effect relationship, but rather a co-incident behavior: The market is at the tipping point of a sell off. The exogenous event merely gives the market the "excuse" it needs to sell off in dramatic fashion, and serves as the scapegoat for the decline.

What will the exogenous event be? Possibly nothing. But in these war-torn and troubled times, any number of scenarios can easily be imagined taking place on the world stage: Perhaps another terrorist attack in America? A nuclear exchange between India & Pakistan? An escalation in the Middle East? Who knows. But the predictive power of the chart is pointing to something big in the offing.

M.A. Nystrom
10 June 2002


* While Mr. Insana is an agent of the corporate televison-media complex, and the book The Message of the Markets is as much a shameless advertisement for CNBC as it is worthy reading material, there is value in his message. I have always thought of Mr. Insana, as well as his colleague Mt. Bob Pisani to be two of the more intelligent talking heads on Bubblevision amid the sea of pretty, hollow faces.

2nd great depression, Michael Nystrom, editor, www.depression2.tv