Kass: Domed ... and Doomed?

NEW YORK (Real Money) -- Back last year I observed that the S&P 500 index was beginning to eerily resemble and track the formation of "Three Peaks and A Domed House" popularized by technical analyst George Lindsay. As the spring became summer last year, Lindsay's pattern seemed to perfectly mimic the U.S. stock market -- and it ultimately gave a great signal that the market declines in August and October were nearly perfect buying opportunities.

I have updated Lindsay's "Three Peaks" regularly over the course of the past six months because many, like myself, were captivated by the strong fit.

Here is the most recent update; if the market cooperates, this setup indicates that an important market top has been formed. ( There are many interpretations of this formation.)


Source: Bloomberg

And here is the historical table of George Lindsay's "Three Peaks," taken from Ed Carlson's George Lindsay and the Art of Technical Analysis that Sir Arthur Cashen was nice enough to send me recently:

It is important to recognize that "Three Peaks" took us to the near-1420 top in the S&P in March 2012 (a market level that few thought imaginable in August or October of last year), and if the fit continues and a stage 23 top has been formed, it "should" take us down more than 20% to about 1100! (If we use the Dow Jones Industrial Average and a stage 23 top has been established, Lindsay's DJIA target would be under 10,500 (down from 12,900 today)!)
Pardon the excessive use of charts today, but it helps me visualize the market situation. As the major averages push on resistance at 4-year+ highs we continue to track the current iteration of George Lindsay's famous Three Peaks and a Dome House Top Pattern (3PDh) in play since last year.

Today we continued our deliberations on this mother of all market patterns with Doug Kass of Seabreeze Partners and Ed Carlson author of George Lindsay and the Art of Technical Analysis.

The three of us basically agree that a market top of some sort is imminent and that a decline of some significant magnitude will ensue. My analysis places the top a little longer and higher away. I do not know at this juncture what either gentleman envisions on the down side, but I have compared my counts to theirs below. Ed uses a later-day Lindsay counting method that does not detail all of the 28 points that Doug and I rely on. Doug has plotted his count against the S&P 500, whereas Ed and I use DJIA.

In any event my count now puts us at the end of the first floor at point 20 and climbing up to the Domed House Top from points 21 to 25. Please refer back to previous posts for Lindsay's Basic Model. I have also posted a candlestick chart of the DJIA in the short term to illustrate DJIA strength, resistance and positive technical indications.

We finally closed above the February 24-27 DF/DM Double Doji as well as the March 2 Doji. I expect the rally to continue into the Ides of March bullish cluster to perhaps 3PDh point 21 then settle back to point 22 at end of March weakness then produce a final point 23 top in April or May as the Best Six Months comes to an end and we get our Seasonal MACD Sell Signal.

-- Jeff Hirsch, Stock Trader's Almanac, "DJIA in Top Formation" (March 15, 2012)

Jeff Hirsch of Stock Trader's Almanac recently updated Lindsay's "Three Peaks" -- but he used the price performance of the Dow (I use the S&P 500 index). My friend/buddy/pal Jeff's conclusion is that if the pattern continues to be of a predictive nature, and unless the market takes out its high close of April 2, Mr. Market faces trouble ahead. (Jeff predicts a likely 5%-15% pullback.)

How should an investor deal with this -- or, for that matter, with other technical observations and patterns?

Here is my thought process of the usefulness of "Three Peaks" and other technical configurations. To begin with, I am a fundamental investor who uses technical analysis for, at most, 10% of my investment decision-making process. Mostly I use technicals in gauging oversold/overbought conditions and supply/resistance and demand/support. For these purposes and other technical signals I rely on legendary Bob Farrell, The Divine Ms. M and Walt Deemer (whose new book, Deemer on Technical Analysis: Expert Insights on Timing the Market and Profiting in the Long Run is a must-read).

To me, Lindsay's "Three Peaks" and other technical patterns should be treated as an oddity, a simple coincidence, and should not be taken as gospel -- much as, for example, Fibonacci sequence, which provides some of the mathematical basis for Elliott Wave studies, should be taken with skepticism. Though nature has its ebbs and tides, technical analysis (that replicates that nature) is a stretch to me.

The fact is that Lindsay's "Three Peaks" and Fibonacci's "Golden Ratios" do not represent consistent financial patterns that we can rely on -- for if it were that easy, everyone would making millions of dollars trading in their homes.

As well, some of the older technicians are just plain odd -- as odd as some of their observations. Just check out this memorable interview with Lindsay (fast-forward to the 1:40 mark) and Louis Rukeyser from "Wall Street Week." Or watch Joe Granville's theatrics, decades ago. Even Marty Zweig sounds somewhat ghoulish (and possibly possessed) in a "Wall Street Week" segment following the Rukeyser interview.

So on this Friday the 13th, my advice is not to be overly frightened and spooked by George Lindsay's "Three Peaks and a Domed House" -- unless it turns out that he is proved correct!

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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