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  Posted on: Thursday, July 26, 2012
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The Market Is Tracing Out A Typical Topping Pattern

   
 
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With the global economy likely headed for another recession, central banks are still attempting to step up their probably futile effort to stop the downward tide by trying to boost stock market prices.  Although we are generally not believers in conspiracies, it does seem likely that the Fed, late yesterday (Wednesday) afternoon, leaked the possibility of an imminent move toward more ease to its favored reporter at the Wall St. Journal.  Not coincidently, the report came out just as the S&P 500 was breaking below the upward trend line in effect since the June 1st bottom.  To add icing to the cake, ECB head Mario Draghi, a few hours later, announced the ECB's intention to do everything it could to keep the Eurozone together. 

The leak by the Fed was most likely a signal that the move toward more ease would come about at next week's FOMC meeting, as anything less would meet with severe disappointment by the market.  By the same token, the ECB, too, will now have to follow up with something more concrete than Draghi's general statement.

In our view, a global recession is probably in the cards despite any actions by the world's central banks (Please see last week's comment in the archives).  While the central banks may have temporarily halted the potential downward break in the stock market, we believe that the peak has already been made, and that the market, at its own pace, is tracing out an extended topping process typical of many past bear markets.

If we look at the five bear markets that started in January 1970, January 1973, August 1987, September 2000 and October 2007 we can see a similar pattern where the market declined after a peak, rallied to a level below the previous peak and then plunged to a final low.  In each case the first decline was relatively benign and mistaken for a correction in a bull market, while the next decline from the interim top was severe and left no doubts.

The first drop after the peak was between 8% and 19% and took one to seven months.  The subsequent rally was between 6% and 12% over 1 to 2 months and fell short of the previous peak.  From that point the final leg down was between 23% and 52% over anywhere from 2 to 12 months.  The total decline from top to bottom was between 26% and 57%.

In the current cycle the S&P 500 peaked at 1419 on April 2nd, this year, and dropped to 1278 on June 1st, a 9% drop over 2 months.  The following rally has so far topped on July 19th, a gain of almost 8% over 7 weeks.  These are within the parameters of prior bear markets. If this market plays out as prior bear markets, which we expect, the next decline will be extremely severe.   

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