Stocks Face 'Black Hole' Bear Market Risk on Nasdaq's Sell Signal

NEW YORK (TheStreet) – Most market strategies still think that the stock market is cheap and have raised their price targets for the stock market indices. I say that if the weekly charts for the five major averages shift to negative this week or next, the July multiyear or all-time intraday highs will be confirmed as market tops.

To review, the all-time or multiyear intraday highs and the dates set are 17151.56 (on July 17) Dow Industrials, 1991.39 (on July 24) S&P 500, 4485.93 (on July 3) Nasdaq, 8515.04 (on July 23) Dow Transports and 1213.55 (on July 1) Russell 2000.

Closes this week and next below the five-week modified moving averages at 16724 Dow Industrials, 1941.5 S&P 500, 4363 Nasdaq, 8153 Dow Transports and 1144.75 Russell 2000 will result in negative weekly charts for all five. What’s preventing this from happening at this Friday’s close is the Nasdaq will still have a 12x3x3 weekly slow stochastic reading above 80.00. These moving averages will be lower next week.

Here’s the weekly chart for the Nasdaq.

Courtesy of MetaStock Xenith

Note that the bull market up trend from the March 2009 low through the October 2011 low lines up with the 200-week simple moving average at 3221, which I consider the longer-term reversion to the mean. This is a risk if the weekly chart shifts to negative. This risk is below my semiannual and annual value levels at 7423 and 3471.

Let’s evaluate the "black hole" possibility where you don’t know what's on the other side.

The first "crunching the numbers" table is an eye-opening reality check.

The second column shows the 2007 or 2008 all-time or multiyear highs before the "crash" of 2008. The second column is the month in which these highs occurred.

Looking at the Nasdaq, the multiyear intraday high for the Nasdaq pre-crash on 2008 was 2861 (column 2) set in November 2007 (column 3). The decline to its March 2009 low at 1266 was 56% (columns 4 & 5). The rally from that low to its July 3 multiyear intraday high at 4485.93 on July 3, 2014, was 254% (columns 6, 7 & 8), which is 57% above the 2007 high (column 9). A decline to that prior high is a "Black Swan" loss of 36% (column 10). If the Nasdaq were to decline to its March 2009 low that downside risk is 72% (column 11).

With this much risk possible investors should make the prudent decision to book profits.

The second "crunching the numbers" table shows the current state of the five major averages.

Shown from left to right is the "December 21, 2013 closes", the "year-to-date gain or loss," the "closes on August 7," the "five-week modified moving averages," the "12x3x3 weekly slow Stochastic" (a measure of momentum).

Next are two value levels, a pivot (considered a magnet) and two risky levels. The letters represent the time for theses key levels, (W – weekly), (M – monthly), (Q – quarterly), (S – Semiannual) and (A – Annual).

Dow Jones Industrial Average (16368): Semiannual and annual value levels are 16310 and 14835 with a monthly risky level at 16871, the July 17 all-time intraday high at 17151.56, and quarterly and semiannual risky levels at 17753 and 18552 (not shown). The weekly chart is negative with the five-week MMA at 16724.  

The S&P 500 (1909.6): Semiannual and annual value levels are 1789.3 and 1539.1 with a monthly risky level at 1970.2, the July 24 all-time intraday high at 1991.39, and quarterly and semiannual risky levels at 2052.3 and 2080.3 (not shown). The weekly chart is negative with the five-week MMA at 1941.5.

The Nasdaq (4335): Semiannual and annual value levels are 3972 and 3471 with a monthly risky level at 4450, the July 3 multiyear intraday high at 4485.93 and quarterly and semiannual risky levels at 4569 and 4642(not shown). The weekly chart shifts to negative with the five-week MMA at 4363 if the stochastic reading, now at 83.63, falls below 80.00 on a scale of 00.00 to 100.00 where readings declining below 80.00 are negative.    

The Dow Transportation Average (7992): Semiannual and annual value levels are 7423 and 6249 with a quarterly pivot at 8256, monthly and semiannual risky levels at 8292 and 8447 and the July 23 all-time intraday high at 8515.04. The weekly chart is negative with the five-week MMA at 8153.    

The Russell 2000 (1119.75): Annual value levels are 966.72 and 879.39 with a semiannual pivot at 1139.81, a monthly risky level at 1156.01, the July 1 all-time intraday high at 1213.55, and semiannual risky level at 1285.37. The weekly chart is negative with the five-week MMA at 1144.75.

Note that the prior cycle highs shown in the first table are below all value levels shown in the second table except the second annual value level at 1539.1 on the S&P 500.

On July 1, I first discussed the "black hole" pattern.

On July 11 as the major averages were setting their highs between July 1 and July 24 I noted the gathering flock of "Black Swans." Today the biggest “Black Swan” leading the flock is the weekly chart profiles. If my scenario pans out stocks could be lower for a long-long time. Similarly, scientists studying outer-space just don’t know what’s on the other side of a black hole.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @Suttmeier

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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