Shown in the chart below is a comparison between the head and shoulders pattern that appears to have formed over the last few months and the very similar pattern from the July-Sep period of 2008. The annotations on the chart use the term "fractal", but it might be better referred to as an analog with the 2008 period.
Following the completion of the pattern in 2008 there was a breakdown below the neckline that went about 60% of the typical measured move for a H&S, which is the total height of the pattern subtracted from the neckline. That initial breakdown was then followed by a sharp short-squeeze that took the S&P well back above the neckline (nearly back to the right shoulder), making it appear to be a false breakdown. The vicious 2-day short-squeeze was triggered by the U.S. government announcement of a short-selling ban on financial stocks. The news was perceived as extremely bullish and scared or stopped out a lot of shorts that were put on during the formation of the H&S and the backdrop of deteriorating fundamentals. After the 2-day short-squeeze ran its course, the market then proceeded to melt down throughout the month of October and put in a succession of lower lows on 10/10, 10/27 and 11/21 before a 6-week rally into 1/6/10 and a final low in March 2009.
The low on 11/21/08 was a break below the neckline of four times the height of the H&S pattern. A similar move, should it occur in the current market, would project to 563 (basis the nearby continuous futures contract) before the end of the year.
These analogs or fractals frequently fail to work out and, at some point, they always stop tracking the previous pattern. However, since we are entering the Oct-Dec season when crashes tend occur, and since this October is 288 months (144 x 2) from the October 1987 crash, and since there will be a Puetz Crash Window in December this year (based on fairly close proximity of solar eclipse followed by a lunar eclipse), I thought it worth posting. This isn't necessarily a forecast, but it is an observation of something to be aware of. I would be particularly alert if we have a decent break below the neckline, followed by a violent 1 to 3-day short-squeeze well above neckline that is triggered by some kind of bullishly perceived news event. If, and that's a big "if", then I would be inclined to fade the news and position for a slide lower.
There is a lot of negative sentiment building up, so this market may need a larger rally before a significant breakdown can occur, but it may be too weak to rally much until there is some kind of capitulation move to the downside. I'm expecting more strength in the dollar, which should add to pressure on stocks (and everything else). Even if there is no similar meltdown as 2008, I have timing (based on other forms of analysis) for potential CITs on the following dates (some of which should be lows): 10/10/11, 10/26/11 to 11/1/11 , 11/16/11, 11/25/11, 12/14/11, 12/20/11, and 12/31/11 (each are +/- a trading day or two). Some cycles do appear to start pointing up after October and, if the market happens to be lower into the 12/20/11 timeframe, I would be looking to cover shorts for awhile. As the title says, the above scenario is just one of a 1,000 possible outcomes, so anything can happen (including a Bernanke surprise that kicks off a substantial rally to 1250 or higher).
Kim Rice 10/2/11
