Technical analysis of the Nasdaq 100 stock index reveals some very alarming signs for the stock market. Here's the weekly bar chart of the Nasdaq 100, zoomed in to show only the period from October 2015 to Friday's close.
All that is visible is the high in December (the highest high since March 2000's all-time extreme), the low in February and the sideways action between those extremes. Notice Friday's close is back to the 200-day moving average, which is a kind of fair value measure of the price vs. the past year's price. Imagine the "scales of justice" at equilibrium, momentarily. Bulls are attaching themselves to anything that supports a breakout to new highs, while bears focus on things supporting a break of the February low. Let's forget about biases and emotions, however, and look at objective indicators.
First, let's look again at this weekly bar chart and notice that there is something visible in this index that isn't visible in the Dow Jones Industrial Average, the S&P 500 or the Russell 2000. That red dot at the December peak is the highest price for this index since 2000. Each of the other indices made all-time highs last summer and have made lower highs since then. This makes the Nasdaq 100 the most recent index to peak from at least the 2009 low.
With that being an empirical truth, we can analyze the pattern off the most recent high for characteristics of a trend change. According to Elliott Wave theory, the appearance of a five-wave structure, without overlap between waves 4 and 2 is required. That is exactly what is visible, which is labeled above with purple 1, 2, 3, 4 and 5. The February low is then labeled with a red 1, with an alternate labeling of red A.
Readers should remember that our decision support engine warned us when the market was making lows in January and February that investors should have been exiting their short positions at that time, because the biggest rise since the December peak was imminent, and it looked like the Nasdaq 100 would probe the 4400 zone before its corrective bounce was over. That has not yet taken place. The labels at the April highs are red 2 or A, telling us that the most likely probability-ranked outcome for the near future is for the February lows to break and be followed by a larger selloff than the last one. This selloff should target 3400 in the next three to five months.
As long as the December highs aren't broken, the bounce can take even more time, and the index could move around 4350 +/-350. Eventually, the red path should be explored. Only new highs would make the blue path dominant, but even that would not last very long. We'll look at the reason why on the next page.
Take a look at the larger degree of trend: the picture that includes the all-time high from March 2000.
Here's the monthly bar chart, showing the manic rise into the dot-com bomb, after which the Nasdaq 100 fell 80% in two years. Most traders weren't around then, so they can't imagine that damage of that magnitude can occur.
Now, notice the objective, empirical similarities that today's market has with both 2000 and 2007. See the bold blue lines in the lower stochastics pane at those previous market peaks? Stochastics made lower highs while the index was making higher highs. This is called a bearish divergence sell signal and is a harbinger of looming trend changes at large degree. The same condition was seen into the December high of a few months ago, and the sharp decline since that high, highlighted by the pink column, is like those of the past two peaks. Also, following the 2000 and 2007 initial decines (pink columns), yellow columns followed that made lower price highs. Again, that just occurred from the February low to the April high.
Following the 2000 and 2007 initial declines and subsequent rallies to lower highs, there were lots of articles and pundit comments advising investors not to panic and telling them that all was well. We've seen similar comments in the past couple of months as well. We have noted, in red boxes, the mood of the crowd at the points after the 2000 and 2007 peaks when prices broke back below the initial lows: Uh-Oh! The next level where waterfall-type selling will appear is the February low of 3888. When that happens, empirical evidence suggests an additional 25% crash should arrive, making the total decline off the December 2015 peak approximately 40%. This would take prices to the red line of support that caught the May 2000 low, and a multiweek to multimonth low could appear. Even that 40% wipeout should not be the ultimate end of the selling that a peak of the magnitude of the 2015 highs implies, however. The path illustrated by the blue arrow shows that scary forecast.
Therefore, if you want to cut through the noise of the bulls and bears talking their books and view the markets objectively, consider using the February lows as the worst-case, lowest price level at which you completely exit stocks and stock mutual funds. An even better place would be on a break of the lower two-standard-deviation band, the golden/olive line in the top chart that crosses 4075 now. This statistical measure controls 95% of normality, and if the index breaks below that level, it suggests equilibrium is about to fail.
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This article is commentary by an independent contributor. At the time of publication, the author held a short position in the PowerShares QQQ Trust (QQQ).