Long term market trends remain intact, yet charts indicate a market on a knife’s edge as significant technical damage has been inflicted. Markets are deeply oversold and the nature of the next rally will be determine whether this bull market can survive or if a larger bear market may begin to unfold. The larger message: New highs or bust.

In this week’s update I’ll give you both some of the bullish and bearish perspectives focusing mainly on technical considerations.

Before I dive into some of the arguments first some context and perspective on this correction because it is so critical to understanding the big picture and why this correction may be different.

In early September in “Lying Highs” I outlined the following:

“A key test may come for markets in the September/October time frame. If prices can sustain above January highs the 3042 technical zone may well be reached in 2018.

If not, the risk dynamic may shift dramatically especially if volatility is breaking out of its wedge pattern”:

Here’s the updated chart:

$SPX fell right into the risk zone tagging the weekly 50MA while volatility broke out of its wedge pattern. In process the 2016 trend line is currently being tested.

Why is this chart so important? Because it ticked off a key element missing in the check list of big market topping patterns: New highs on large negative divergences.

In April I wrote a piece called “The Big Market Tops”. If you haven’t read it I encourage you to have a look as it outlines some of the key elements common to larger market tops.

In that piece I concluded:

“The current market action is exhibiting elements of a market having entered a potential topping process yet several historical elements are still missing to confirm a top being in place, hence staying open minded and flexible may not be the worst course of action”.

Tops are generally processes that advertise trouble in advance in the form of negative divergences as they indicate weakness underneath the exuberant price action. Those are currently not in place.”

Now they are.

Indeed the lead up to this latest correction advertised the weakness underneath and negative divergences well in advance and the consequences are now obvious. A couple of quick, but important examples:

On the day of new all time highs on the $DJIA I highlighted the negative picture in new highs/new lows:

It indeed signaled what was to come:

Another key signal was equal weight diverging negatively:

That lower high on $XVG as $SPX made a new high was a key signal:

And we saw warning signs in the individual stock and index charts. Example here is the $NDX:

And we just saw the results:

As I said on the outset: The technical damage inflicted is severe as markets printed rising wedge breaks and a rejection of new highs.

Examples:

$WLSH:

$TRAN:

$NYSE is just a broken chart:

$SPX:

This is just technically plain ugly as trend line after trend line keeps breaking to the downside.

Indeed the damage is so severe that 3.5 months of relentless summer buying was wiped out in a matter of days:

The main point here: Negative divergences and weakness underneath on new highs produced a major breakdown from new market highs.

And by doing so markets are following a historic script of eventually far reaching consequences:

The most recent bull market tops came on multi year channels and/or rising wedges that eventually broke their trend support on negative divergences. This current wedge is extremely steep and narrow. The 2009 support trend line has not broken yet, but got awfully close last week.

And let’s be clear: If this support line sees a sustained break the bull market is over.

Note the key previous trend line saves came in context of record global central bank intervention in 2016 and 2017 and the blow-off push over the 1987 trend line in January came on the heels of US tax cuts. The most recent highs again pushed against the trend line and failed again on a negative divergence.

The context of rising yields here is critical as yields are threatening to see a sustained break above the long term $TNX trend line, the most recent trend lines tags coinciding with the end of the previous bull markets.

In February in “The Ultimate Bear Chart“, I highlighted a potential key ratio relationship between bonds and stocks.

I said at the time:

 “I’m not calling for an immediate collapse here, but I’m pointing to a possibly huge structural relationship between bonds and stocks, one that will likely take years to play out. But the signs of trouble are already in this chart.”

Here’s is the updated chart:

Back below the 2012 and 2013 highs, just falling out of a bear flag as $SPX is testing its 2009 trend line and $TNX is breaking above the 2013 highs.

Put this all together and you have this macro context:

The main message for markets: It’s a key time here because the potential consequences of a technical breakdown are severe and let me give you one chart to highlight this, the larger market index, the $VTI:

Like many of the index charts it made new highs on a negative divergence. This most recent correction has reconnected with its long standing support moving average the weekly 50MA. And this support tag is highly suggestive of a coming rally and I’ll discuss this further below, but note that the recent highs created a major technical confluence aligning the .382 and .50 fibs with the key price pivots of 2014-2017.  This is suggestive that a confirmed break of the bull market would invite a technical price retests to at least the .382 fib initially, implying that the entire market rally since the US election will be retraced at some stage.

But we do not have a confirmed break and hence I want take some time and focus on the bullish view which is the common perspective here, the one says none of the above matters.

After all every single correction since the 2009 lows has been a buying opportunity during this age of permanent intervention and artificial stimulus.

The bullish argument: Hey, we just tagged the 200 day moving average and look how magically we closed Friday again above it:

A quick look at the larger picture of 200MA corrections lends credence to this perspective:

And note how oversold we are now. This most recent RSI dip is actually quite historic. Just take a look at the $RUT to get the perspective:

It’s the most oversold reading since the 2011 correction. But that may actually be a bad sign, and I’ll address this further below.

Look at $NYMO, it almost hit -100 last week, key reading suggestive of a bounce to come:

At the same time note the key trend line “saves” we witnessed last week besides the 200MA on $SPX.

Examples:

Here’s the $DJIA:

Here are transports:

Here’s $JNK:

Here’s $TLT:

Here’s the $NDX:

All saved. For now.

And note how last week’s correction served to reconnect with key moving averages as support.

Examples:

$NDX tagged its weekly 50MA:

At the same time it reconnected with its quarterly 5EMA which was overdue:

In short: One can make a solid case here as to why we should see a sizable rally off of these trend line saves and MA reconnects in context of the deep oversold readings either from last week’s lows or any new lows.

In fact the bullish view would suggest that this correction is simply another quick washout before year end positive seasonality and as record corporate buybacks will return following their recent blackout period.

After all, the CPI chart shows no breakdown yet (lagging data):

And I would support this view as long as the 2009 trend line does not break and new highs can be made which then leave the technical 3042/43 target zone intact:

But be clear: The road to new highs is paved with brutal resistance:

The January highs are resistance. The broken 50MA is resistance, as are the fib levels above and the chart shows a clear potential double top. The technical damage is so vast that it won’t be easily repaired.

Bottomline: Bulls have a lot to prove here.

I’ve said on previous occasions that there is no evidence that suggests that markets can make and sustain new highs without renewed central bank intervention and/or stimulus in some form. We simply have not seen markets operate without any of these in play in some form or another since 2009 and now, for the first time, there is no clear visible path of new intervention being on the immediate horizon.

As we see markets work off oversold conditions I’ll leave you with 2 charts to consider as well.

Volatility has broken out hard:

$VIX RSI is currently overbought, but note we now have seen 2 major wedge breaks to the upside. The 2017 wedge broke to the upside in February, has since build another, higher wedge, and this has now broken to the upside as well. The message: Volatility, in the big picture, is increasing to the upside and low volume summer conditions simply masked that trend.

One other chart that should raise some eyebrows. Yes we are massively oversold, but are we too oversold perhaps indicating this sell off was different and a bearer of things to come? Sounds counterintuitive, until you look at this chart:

Last week’s decline was so outsized on the oversold front that it printed the largest oversold RSI reading on cumulative $NYAD since 2008.

That print back then, was not a bullish print. It worked off oversold conditions and the rally it produced failed.

If this next rally fails, the 2009 trend line may end up broken and with it the bull market.

New highs or bust.

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Authored by: Sven Henrich