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Megaphone Pattern in the Dow Jones

The overarching pattern in stocks that I have been following for years is called a megaphone pattern. It is simply a series of higher highs and lower lows. The S&P 500 traced out a large

The overarching pattern in stocks that I have been following for years is called a megaphone pattern. It is simply a series of higher highs and lower lows. The S&P 500 traced out a large megaphone pattern with three tops in 1965, 1968 and 1972 just before the big crash of 1973.

The first major bubble in the Dow began in November of 1994 and topped six years later in January 2000. That was the first high. The low came during the October crash of 2002.

The second high (and higher than the previous one) came in October 2007 and soon followed by the lower low of March 2009. Now we’re potentially seeing the final top forming.

The final top (or E wave) can often go a little above the trend line as it has recently been hitting 17,638.

It shouldn’t go much higher than 17,700.

If this megaphone pattern continues to play out, then the big crash would seem more likely to occur in the 2015 to 2016 time frame, as it did back in 1973 to 1974, just after the last major long-term stock peak from the Bob Hope generation spending wave.

Stocks could head substantially higher if the broader Dow megaphone pattern is violated.  The only resistance level left for stocks would then be the 2000 peak for the Nasdaq at 5,050.

That would represent a major B wave peak and it would be very unlikely that it would be exceeded, or at least not by much and imply a Dow as high as 19,000 and an S&P 500 as high as 2,200 — which is around 8% higher than it is currently.

Time to Rally

I’m in total agreement with an observation Adam O’Dell made last week. He said that in the last several months the market has been reaching higher highs and lower lows and that if the next correction likely just ahead sees a lower low after the extreme spike from October 15, then a top is likely been put in.

If it doesn’t, then the markets are likely heading to substantially higher levels.

The higher highs and lower lows Adam was referring to form a mini megaphone pattern as the chart below shows. The July peak was the first high. The second peak was in September followed by a lower low on October 15.

The current rally would represent the E wave if this megaphone pattern continues to play out. The target for the next lower low would be around 15,500 and should occur by mid-December or so.

See larger image

If we see such a lower low, then it’s highly likely we put in a top in November. If we instead get a correction in early to mid-December and we’re not seeing a lower low and/or the market is starting to rebound strongly, then we’re very likely to break above the broader megaphone pattern and see substantial new highs in the months ahead before a final peak.

My best short-term cycle expert, Andy Pancholi in London, has a minor turn date around November 14 for stocks and a major set of turn dates between late February and mid-April, especially around mid-March.

We’re likely to either see substantial new highs or a crash into this March time frame. Stocks are now as overbought as they were oversold on October 15, so a correction is very likely in the coming weeks.

What’s the Smart Money Doing?

Adam noted that the advance/decline line (which shows more selective buying of larger cap stocks) is not confirming the new highs in stocks as of yet, but it certainly would if we break well above the broader megaphone pattern. I commented last week that rising trends in buying power and falling trends in selling pressure on this recent rally is the one major indicator that would suggest that the top has not been put in yet.

This indicator is saying that the “smart money” is not exiting yet. But what if they react differently this time when the Fed seems to be guaranteeing that the markets won’t fall very much?

The rally we’ve been experiencing since March of 2009 has been the trickiest in history because it’s an artificial rally fueled almost solely by unprecedented stimulus measures. Many technical indicators and leading indicators simply don’t work anymore because the markets have been essentially taken over by central banks.

The one thing that has worked better is the visible patterns in stocks like head-and-shoulders, channels, wedges and megaphone patterns. Although I had a key wedge that was broken on the downside on October 15… this sharp rally occurred to new highs despite of it.

I still warn that it’s better to get out a little early than too late as such an artificial bubble rally will likely see a swift and violent crash when it does finally top. The Nasdaq crashed 40% in its first 2.5 months of the down wave in 2000.

If, by December 10 or so, we do see the markets holding well above the October 15 lows then the odds are the markets are going higher. Investors who have sold could then choose to get back in altogether or in steps and increasing your exposure if we do break to new highs above the levels achieved in November.

I wish this market wasn’t so hard to read but that’s the hand we’ve been dealt. But make no mistake, this is a bubble and the lagging performance of small-caps is a clear sign that the end is near.

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