Tuesday 1 May 2012

RETURN TO THE DOME OF DOOM








Back in the spring of 2011, I published a post which made what seemed to many an audacious, even outrageous, market call.  It revolved around the dramatic re-appearance of one of the weirdest patterns in technical analysis: 'Three Peaks and a Domed House'.




This pattern warned of an imminent and spectacular stock market collapse which, whilst affecting all of us, would fall hardest on one far-flung region of the world. Those who took note of my call know what happened next.  Almost exactly one year on, the pattern has re-emerged - but this time its potential for destruction is even greater.  Because it now appears a market tornado is brewing which will, if it triggers, touch down right here in our own back yard.



Just as hope continues to float among American investors today, you'll recall that late spring 2011 was a time of rising optimism across markets worldwide.  Since the fall of 2010, stocks globally had soared following that injection of Grade-A financial smack by the Federal Reserve known as QE2, a rise seemingly confirmed by improving growth figures among many of the world's major economies.  




Prime Minister David Cameron felt confident enough to announce repeatedly that the UK economy was "out of the danger zone", a proclamation which may go down alongside Gordon Brown's boast that he had "put an end to boom and bust" as one of the most notorious hostages to fortune in political history.




Financial advisors were particularly busy recommending their clients pile into Emerging Market stocks, which had been going gangbusters since 2009.  




At the beginning of April 2011, a simple line chart of the widely watched ishares Emerging Markets index, an aggregate of the world's biggest EM stocks, looked like this:








Most investors, seeing the line travelling steeply from the lower left to the upper right, had no reason not to consider the outlook extremely bullish.   




But then that's why you, unlike most investors, visit this blog, isn't it dear reader? 




In my post that month entitled 'The Curse of the Domed House', I used the Three Peaks technical pattern to suggest strongly that Emerging Market stocks were set to plummet by a minimum of 26%.




Here is the same index as it looked seven months later:








From its April 26th 2011 closing high to its Oct 3rd low of 34.03, ishares EEM plunged by 31%.




An investor could have used this insight either to exit or hedge his EM holdings - and a trader could have enjoyed one of the most lopsidedly advantageous risk/reward trades of 2011.




In the three brief videos which follow I hope to show not only what makes the Three Peaks technical pattern so deadly, but how that pattern may now be setting up ominously in the most significant and influential of all world stock markets, the US S&P500






PART ONE



Please play in fullscreen mode for HD clarity 




PART TWO









PART THREE











CONCLUSION




My regular reader and my patient Twitter follower will know I've been highly bullish on stocks and positioned long since the beginning of 2012 - with one caveat.




I stated consistently that 2012 would likely deliver a binary outcome, either hugely higher or lower, with no room for fudge or muddling-through.  Certainly the weight of technical evidence at the start of the year, together with very positive price action, suggested a continued powerful rally was on the cards.  




But recent data - both fundamental and technical* - is now making the bullish case less compelling and is opening up the genuine prospect of a bearish outcome.




Hope for a positive resolution and even greater gains is by no means lost, yet hope is not an investment strategy.  By definition, at a top greed is rampant, bearish evidence is ridiculed and almost no-one can see why a market should fall.  




My job therefore, as investor and humble messenger, is not to wish the real world away but to poke holes through the thick curtain of illusion and wishful thinking which descends near market peaks and try to see things as they really are - then tell it like it is in time for my reader to avoid taking a financial enema.  




If we are going to have to go through more turmoil - as I've long been convinced we would - then we must prepare, protect ourselves, and try to prosper in spite of it all.




Having said all that, price action remains king.  Unless the technical evidence for a reversal becomes overwhelming - including but not restricted to the triggering of Three Peaks and a Domed House - I remain a determined bull.  




My inner bear, however, is sharpening his claws.






* I'll devote a separate post to the bearish evidence if and when it becomes too compelling to ignore, but for a taste of my recent reading you might like to check out this, this and this.