The Ugliest Chart Of All Time

July 5, 2010

The following chart is my number one reason to be bearish and to believe we are in the worst bear market of our collective lifetime.

Some things speak for themselves and, unfortunately, the long-term chart of the S&P 500 is one of them. It's hard to argue that the direction, the path, the trend of the S&P 500 is anything but volatile and down.

A Brief Discussion of Its Double Top
Although it really doesn't matter what you call it since it is clearly bad, very bad, this chart shows that the S&P 500 is trapped in a confirmed double top.

This negative reversal pattern is identified, in part, by its well-defined peaks that are within 1.9% of each other and the 7 ½ years that separate them. Its hallmark, however, is found in the fact that the index closed at 798 in Q1:09 and through the pattern's Q3:02 breakpoint of 815. It is this last point, or the breaking of support between the two peaks, which is considered to be the defining characteristic of a double top.

Caught in a confirmed double top, then, the S&P 500 carries the burden of the structure's formal measuring implication which is derived by taking the length of the first down-leg and projecting it downward from the breakpoint. This provides us with a technical target of about 100.

The "What" It Shows
As a summary of my longer papers, I think the S&P 500's long-term chart tells us the story of the world's unsustainable borrowing activities over the last 30 years.

I define borrowing as Total Net Borrowing ("TNB"). This is the Federal Reserve's record of credit market instrument use in a given year as opposed to total debt outstanding. As such, its year-to-year changes are rather instructive about the activity of borrowing as are the changes in its different sector components.

Total Net Borrowing (All sectors credit market instruments) plummeted to -$660.1 billion in 2009 from its peak two years earlier in 2007 of $4.5 trillion. This is nearly an inconceivable level of change to have occurred in just two years.

Total Financial Sector borrowing (Total finance credit market instruments) plummeted to -$1.8 trillion in 2009 from its peak of $1.8 trillion in 2007. This too is nearly inconceivable to have occurred in such a short period of time.

Total Net Borrowing ($B)

Source: EconStats, the Federal Reserve
Total Financial Sector Borrowing ($B)

Source: EconStats, the Federal Reserve

As I wrote yesterday, what goes up must come down, and quite clearly, borrowing, and especially financial sector borrowing has come down and then some.

For an economy that runs on money and credit, such a plunge threatens the very viability of the system and for precisely this reason, the Federal Government attempted to "regrease" the system in the fall of 2008 with its own borrowing activities. In fact, TNB would have registered at about -$2.0 trillion in 2009 had it not been for that borrowing.

And while the Federal Government did the right thing in fulfilling its role as Lender of Last Resort at that time, I believe those liquidity actions simply delayed the inevitable. Had the Federal Government stepped aside, I firmly believe that the system would have collapsed already and that collapse would have been the "what" shown by the S&P's double top and it, too, would have fulfilled its technical target of 100 by now.

Instead, the mangled half-peak jutting from the right side of the S&P500 is the pictorial form of the government's extraordinary liquidity efforts. And so, the pain of the true double top was put off by the Federal Government and the "what" was altered.

For reasons outlined in great detail in Lender of Last Resort Crisis (May 5), I believe the "what" we are facing now has to do with weak or failed Treasury auctions and a severely devalued if not collapsed dollar.

I may be wrong that this is the "what" and I sincerely hope I am because it will be a particularly painful reality here in the U.S., but even so, and this is the important part, the long-term chart of the S&P 500 is telling us that something as severe as its malignant shape is coming irrespective of what it is.

As a result, the message of this chart is pretty clear to me: we are in the worst bear market of our collective lifetime.

Sam's Stash, Gold, and the S&P
I first wrote about the 10-year Treasury staying below 4% with "a possible spike down" on March 26, when most of the big banks were talking about a significantly higher yield, and it appears the 10-year is truly in the former territory having gone below 3%. There were two reasons for my belief back in March. First, it fit the story of what was happening in Greece. Second, and more importantly, it's what the chart below tells us with its clearly downward-sloping trend.


Source: YHOO Finance

I continue to believe Treasurys will remain strong in the near- to mid-term as a safe-haven play before collapsing for the reasons discussed above. I will discuss at length in future notes how such a collapse might play into this chart.

The dollar firmed modestly this week and perhaps in reaction to renewed fears over a possible implosion in Europe. I would have to believe that this trend will continue for a considerable period of time as "safety" is sought. However, it should be noted that the chart of the dollar index clearly shows the possibility of a near-term double top, as occurred in 2009, while its long-term trend is decidedly down. Either supports my belief that the dollar will be devalued greatly at some point, but I have to think the reserve currency is going to continue to look good in comparison to rest of the world for at least another year or two. If not, and as I wrote last week, this will be a very rude awakening for us all.

Gold appeared to do very little this week from a trading perspective and remained rather tightly range-bound. The long-term chart of its proxy GLD (not shown this week) continues to show a clear upward trend and this is supported by the gold thesis or the idea that gold will remain the transferable storage of value should paper currencies collapse. Based on the long-term chart, which is a very nice chart, I am more inclined to believe it will continue to climb higher, but the recent movement seen in GLD has yet to prove that that is completely the case.

And lastly, returning to the S&P500, I will admit that I feel badly about this one. It was an awful feeling knowing before the fall of 2008 that some sort of a crash was coming having stumbled on the then non-confirmed double top in September 2007. When it started to come true, it felt like a bad dream, a nightmare really. It doesn't feel quite like that yet, but I have felt a little sick watching it trade off over the last couple of days.

In part because I think there is a possibility that we could see the S&P500 decline sharply and quickly now that it appears to have found the bottom of the broadening top or "megaphone" negative reversal pattern that I've been writing about for a month.

It is distinguished by its mainly higher highs and intermediate and intervening lower lows which take the shape of a megaphone. Most important, its apparent bottom has been put in and right around the level that veteran technical analysts correctly identified as critical support for the S&P, or 1040, and it now appears poised to make a decline equal to its height dropped down from its bottom. This puts the index, generously, at, 950.

The real problem, however, with the S&P500 falling to 950 is the fact that there is no real support between it and 880. As you can see in the 2-year above, it is vertical between the two points. It appears, then, that if the S&P 500 fulfills the megaphone pattern and falls to950, it is very likely to decline to 880 shortly thereafter.

To make matters more frightening is the looming Death Cross, or the 50 DMA crossing below the 200 DMA. Perhaps it is warning us of such a steep decline too. Such a cross will certainly be interpreted as bearish since the downward direction of momentum will be clear while the longer moving average will become resistance.

Let's hope, then, that the Death Cross holds off and the broadening top does not fulfill itself. For while 880, or more precisely the plateau of 881, 880, 883, and 880 made between July 7 and 10 of last year, offers support above the current bear market low of 677, there's little beneath it to act as back-up.

"And 677? 677 is not support of anything. It's a trap door in the floor."

I know - one of my old favorites twice in two days. And since it does support my view that we are in the worst bear market of our collective lifetime, you may be reading it many more times in the coming weeks.

As always, thank you for taking the time to read this week's piece.

Abigail F. Doolittle
Peak Theories Research LLC
www.peaktheories.com
abigail@peaktheories.com
518-391-9313

 


Abigail F. Doolittle

Abigail F. Doolittle is the founder of Peak Theories Research LLC, which is an on-line research firm dedicated to providing investors with a macro long-term view on the financial markets and the economy. The firm's research begins with the analysis of charts and then ties in various economic fundamentals to better understand the trends pointed to in the charts. She has more than 12 years of experience in the financial services industry.


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Gold is using for heat dissipation in some cars.

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