The End Is Nigh

The Irrational Market Is On The Verge Of Imminent Collapse

I have ridiculed the ridiculously insane market in several recent market commentaries (1, 2, 3), but this piece is more serious.

The End Is Nigh

I was reading the charts for the Dow Jones Industrial Average (INDU: 11003, -38) today and couldn't help but noticing a prominent pattern in its daily chart: Since early December, the Dow Jones Average has been oscillating with ever increasing intensity, making ever higher peaks and ever lower valleys, with increasing volume. The result is a formation called the "Expanding Megaphone Top". (The same expanding megaphone pattern is also in today's intraday chart.)

According to technical market analysis theory, the Expanding Megaphone Top indicates that the market is in a stage that is extremely emotional and is getting out of control. This pattern is a bearish signal and often signals the end of a major bull market.

There has been several reversal signals in the Dow recently. In late January, the Average decisively pierced the previous support near 11000 and dropped to around 10700. The monthly Japanese candlestick chart of the Average shows the classic "dark cloud on top" reversal pattern. Recent downward short term reversals have been strong and decisive, while upward recoveries have been weak and lackluster.

The market is also on a stage of broad popular participation -- the trading volume for the Dow has nearly doubled in 4 months and tripled in 2 years. These days, it is rare to find anyone on the street who is not trading stock on the internet. According to Contrarian Theory, the opinion of the majority is always wrong, and broad market participation frequently signals the top of a bull market.

My previous commentaries have focused on the Nasdaq (COMPX: 4073, +21), why the sudden shift to Dow? Nasdaq, too, have recently staged two strong short term reversals, on Jan 3 and Jan 24 of this year, while the recoveries have been lackluster. I believe it is currently in the process of forming the classic Head And Shoulder shampoo, excuse me, reversal pattern.

I have been interested in the Dow because it has recently served as a leading indicator for the bear market. Its most recent slide, for example, began Jan 18, a week earlier than Nasdaq. The fact that Dow has exhibited strong reversal signals should serve as a warning signal for Nasdaq, because the market will never diverge for long.

Psychology of Round Numbers

Decimal round numbers mean zero to me, but a lot of people treat them with considerable respect. The millenium New Year was celebrated with great fanfare. For many people, 10x birthdays are a time for reflection, frequently accompanied by mood reversals.

Round numbers are also important milestones in the financial market. The Dow often find resistance on 1000-multiples. The Gold price bubble of the 1970's ended when it reached $800 an ounce. The recent phenomenal rise of Qualcomm ended at precisely $200 (or $800 pre-split).

The market also pays great attention to round numbers on the calender. The Japanese stock market bubble was popped 2 days before Jan 1, 1990. The Gold price bubble of the 1970's was pierced a few days after Jan 1, 1980. Since the early 1900's, the U.S. stock market frequently tops out near the first day of each decade and didn't recover for years.

This year, the big round number with 3 zeros, started with a major reversal on the first trading day, and seemed destine to follow the course of other market bubbles. But both the Dow and the Nasdaq Composite ended up making newer highs 3 weeks later. Was that the last breath before the big crunch?

Both the Japanese bubble and the Gold bubble lost 60% of their values when they bursted. How bad will the bursting of the US market bubble be, with Nasdaq increasing more than 80% last year? Hundreds of mutual funds doubled or tripled last year. How many will lose 50% or 60% this year?

02.02.00