In this third part of our 3 part series (see Part I: Central Banks & Part II: Fundamentals) I’ll be discussing the technical picture and my emphasis will be on longer term charts. The shorter term set-ups, levels, direction, strategy etc. are discussed in our Daily Brief.

Given what was outlined in Part I & II what do the charts suggest? After all, some indices just recently made new all time highs and cumulative breadth has been so incredibly positive. I’ll share with you what I am seeing from a macro perspective and you are of course welcome to draw your own conclusions.

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The major theme I am seeing is the following: Recent highs on some select indices have come on major negative divergences, rising & narrowing wedges and were curtailed by trend line resistance.

Let’s start with the structures.

The recent high on the $SPX was rejected at a trend line that connects the 2000 and 2015 highs:

We also have a rising support trend line that connects the 2009 and 2016 lows. A sustained break of this trend line would technically be extremely bearish.

Note that this recent high came on a negative RSI divergence. Negative divergences indicate underlying weakness of a rally.

Let me also highlight this point with the monthly version of this chart:

New highs on negative RSI divergences can be a classic trap in the sense that people get bullish on new highs, yet the underlying technical picture indicates weakness, ergo new highs are actually bearish in such a set-up. The reverse is often true at major bottoms.

We can also observe a major negative divergence on the recent highs on the $NDX:

These divergences can also be observed in the number of stocks above their 50MA. In both $SPX and $NDX the recent highs came on fewer stocks participating:

Also of note: The often quoted positive breadth in markets also came on a very pronounced negative RSI divergence:

And aside from the rally having been pure multiple expansion we can also observe that insider buying had also negatively diverged from price in a big way:

And the $XVG value line geometric index (equal weight) has also shown a major negative divergence as the $SPX made new all time highs on a familiar pattern structure:

These are examples, but they highlight a major point: Recent highs have come on pronounced negative divergences.

Now let me draw your attention to several indices that have NOT made new highs recently and I’ll start with the biggest index of all: The FTSE All World index.

After all the world is awash with central bank action, stimulus, low rates, etc. You’d expect massive new highs everywhere, but we know this is not the case.

Not only has it not made new highs, it rejected again at the 2007 highs. And, also of note here, the index is rising in context of a lower narrowing rising wedge:

The implication: A break of the wedge would be extremely bearish. However, and this needs to be stressed as well: The wedge hasn’t broken yet and its pattern extends higher still and could extend into spring of 2017.

This chart is a reflection that global indices have been underperforming the US. The German Dax is such an example.

Here too we see evidence that all efforts by the ECB have not produced new highs, but rather the index seems engaged in carving out a major topping pattern with a bear flag in potential play:

Coming back to the US: Here too we see rising wedges in context of lower highs.

Example: The Russell 2000. Please note here I am connecting the 2007 highs with the 2015 and 2016 highs (I’ll get back to this later in regards to $SPX).

But here we see that the lower trend line has already been broken and the recent rally’s attempt to recapture the broken trend line has so far failed. Not only that, here too we see a lower rising wedge having formed:

That’s frankly a sneaky chart. It says the larger wedge is already broken and the rally is fake. And we can observe this type of structure on other indices too, check the $NYSE:

And check the $WLSH which actually did make new highs, but in context of an already broken wedge:

Why did $NDX and $SPX make new highs, but the broader indices did not? Simple: The chase for yield, the run into high dividend yielding large cap stocks.

Hence an index like the $DJIA has not broken its wedge yet:

The $SPX seems to be playing some tightly wound middle ground game here. And note: Using the 2007 high as a source $SPX has further upside potentially in play. But it may be difficult if it breaks the lower wedge first.

Rising wedges on negative divergences.  That’s the common theme and you can find it in some of the largest, most popular, even centrally bank owned stocks.

Examples in high cap tech:

$FB: Getting thin?

$AMZN: Have I mentioned negative divergences?

$GOOGL:

Now one can choose to believe these stocks will rise forever, however these ever narrowing wedges on negative divergences suggest that, when they eventually break, sizable downside is to follow.

One of the biggest drivers of the rally since the February lows has been the miraculous recovery in high yield bonds.

Check its ETF, $JNK. It recently also made a new high, yet check this extremely steeply rising wedge. A break lower could seriously test this year’s rally:

Which brings me to financials. Not anywhere near highs and here too we can spot already broken trend lines.

Example, $GS, still below its monthly 25MA:

The broader banking index $BKX, lower highs:

Conclusion: I can’t predict what the Fed will do, or who wins the presidential election nor can I predict what the reaction to any of these events will be, and I can’t predict if there will be a recession in 2017 or 2018, but I’ve outlined the risk factors.

What I can say is this: There are distinct negative patterns in all of these charts and new highs may be deceiving. Yet these rising wedges have not broken in some cases and can continue higher. One can certainly envision the Fed backing away from its tough rate hike talk and appear “easy” again and hence another “relief” rally ensuing. After all their track record is to talk tough when markets rise and cut and run and do nothing when markets sink. So we could see another replay of this game and these wedges are pointing to a potential spring time 2017 high.

But let me be clear: Whether in 2016 or in 2017, these rising wedges demand a resolution and they will get it.

In May (Fatal Attraction) I discussed technical targets to the upside and downside should we break up or down out of the price consolidation. Now that we have made new highs I can observe vast negative divergences.

To me markets remain afloat due to aggressive and persistent central bank intervention as we discussed in Part I. So far they have proved themselves successful despite the underlying picture as outlined in Part II.

In markets past these negative divergences have meant something. And considering they come in context of narrowing and rising wedges, combined with the fact that markets haven’t really technically corrected since 2009, a break of these wedges could have very meaningful consequences to the downside.

So here is how I see it on a macro level:

The $SPX has rejected the 2000 to 2015 trend line. This is now resistance. Should markets rally into year end we could see a tackle of the 2007 source trend line. Currently this trend line sits near 2262 but is rising, and the wedge peak pattern is pointing to a peak in the spring of 2017. Consider that trend line a target if the Fed goes easy again, more central banks add to their easy stances, and they all remain in control of markets.

However, should these wedges break for any reason, i.e. the presidential election, a sudden confidence loss, surprise Fed action, data worsening and/or recession becoming more likely, or a trigger nobody saw coming, then technical downside targets are meaningful and real.

For example: A mere 20% correction, something that hasn’t happened since 2009, would target $SPX 1745 under the current high scenario and a .382 Fib retrace (just a basic technical retrace) would target 1610 on the $SPX. If you think these targets are outlandish, take a look at the actual GAAP earnings and how they relate to previous similar levels on the $SPX:

I’ll leave you with one short term picture. The $SPX is approaching multi short term trend line support and Friday’s decline leaves markets short term oversold:

Should markets break below this support zone in the days ahead the next key level of key support is near 2050-2057 $SPX again. I say again because the $SPX 2050 zone was the central pivot zone of this market for over a year and a half. Also, there is key confluence support in this area as the daily 200MA (moving average), the weekly 50 and 100 MAs and monthly 25 MA all converge there, a very rare multi-time frame confluence. A move toward there would constitute a 6.7% correction off of the highs, a very standard pullback that we have seen multiple times since 2009.

However, a sustained break below this zone risks breaking all the rising wedges I have talked about. And then we are talking about a very different market. Negative divergences may not seem to matter for a long time, but when they do, they really can hurt.

Closing: Thanks again for all the supportive feedback. I’ve posted these articles on twitter, but as indicated this summer (Unplugging) I’m heavily curtailing my activity on social media. You can follow public posts also on Facebook and our daily updates are available via the Daily Brief.

Sven Henrich