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Why the Dow Jones Industrial Average Could
Begin a 70% Decline in the Next Few Weeks
By: Ken Goldbreg of www.thestreet.com 2-13-15
There is a rare bull market pattern that, once it ends, is one of the worst formations that can occur. It has two names. Some call it the megaphone pattern, as its shape resembles what many know as the voice amplifier that coaches and referees use to get large groups of people to pay attention.
Those who know its implication for the financial markets refer to it as the Jaws of Death pattern. In fact, both names have meaning for this ominous indicator of egregious crowd bullishness. Its megaphone analogy reminds us that when this pattern appears, investors need to pay attention that the party attitude of recent memory is on it's "last call." The Jaws of Death descriptor is clear. When the pattern ends, the jaws snap shut like those of an alligator chomping down on hapless prey that got too close to the water. Click on the picture below to enlarge it.
Above is the monthly bar chart of the Dow Jones Industrial Average (^DJI) , from the 1987 crash low (far lower left of graph) near 1600. This is the origin of the pattern, too. The green box highlights the zone between that low and place where the lower jaw line (connecting the 2002 low and the 2009 low -- the bottoms of the two biggest market crashes since 1929) will intersect a dramatic crash if one occurs within the next three years (around 6000). However, since the pattern began at the 1987 crash low, a complete round trip to the beginning cannot be ruled out, although it's not required. The price highs of December 2014, as well as February, March, and May of this year all tested the upper jaw line within 0.5%. These achievements mark the second, third, fourth and fifth tests of this monster trend line in the past 186 months (15.5 years); about 2.7%. In other words, this is a rarity of irrational exuberance.
But the exuberance doesn't stop there. Click the link to expand the chart and observe the bearish divergence sell signals that occurred at the 2000 and 2007 peaks, labeled (A) and (C), where higher highs in price were met with lower highs in stochastics. The same signal was just triggered at the May high this year and will likely recur if the Dow sneaks a new high in price into history to test the upper jaw line again. Regardless, the last two times risk of portfolio wipeout was this high were 2000 and 2007, and we can see what happened next: 35% and 50% Dow crashes, respectively; and 50% and 50% S&P 500 crashes. The crashes were even worse for the Nasdaq and Russell indices).
What about that awesome rally on Friday? Well, looking at the internals, we notice that Friday's 370-point rise occurred with a muted 65% of stocks advancing. This compares to Thursday's decline of 252 points, when 81% of stocks declined. So, although the "manipulators" got the headlines, the story was told by the crowd.