- New Science in old markets -

Equity markets drop from top extensions – don’t get too bearish here

The general selling pressure that has been building in bonds finally spilled over into stocks last week and prices dropped sharply. We have been pointing out for some time that there have been top extensions at every time frame in US equity indices and this drop is most probably the first sign of the end of the bull market.

As pointed out in the first chart, bull markets generally don't end this suddenly - there is usually a period of 'churning' in which prices form a 'top' from which they later can fall. The evidence is mixed as to whether that will happen here:

Valug and Philly wkly tops update

The second chart is one example of a few indices that made a series of weekly tops late last year and then dropped for a short while, regaining and slightly exceeding those highs only recently. This was a part of the 'divergence' that we pointed out at the time (a way of looking at markets invented by Charles Dow in the 19th century - see our video) and looks as though it was the beginning of the end of the rise in some sectors. If so, that 'topping' process is now quite well advanced and so more serious declines could be quite near at hand.

It is not all immediate gloom however, as there have been a couple of shorter-term bottom extensions already, which argue for a pause in the decline, or a bounce from hereabouts:

FTSE & Can bott exts

Bottom extensions have also been seen in US government bonds, which is no surprise since the weakness started there and the decline has accelerated in the last two days:

Bonds, Notes, Note yld exts2

Two European government bond markets have also extended - Germany and the UK:

Bunds, Gilts bott exts

Which, when all is considered together indicates that some pause or near-term bounce in financial asset prices is likely from around here. Be careful though, as being a day or two early in covering shorts (or trying to buy for that bounce) can be expensive when prices are falling so quickly. Better to wait for some 'confirmation' from prices before acting. This could be some short-term price activity that implies a reversal is imminent or perhaps some bearish news item will emerge that fails to cause a further drop further on - that would provide a useful clue.

All signals courtesy of software supplied by our friends at Parallax Financial Research www.pfr.com