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HEAD & SHOULDERS


The Summer Rally This Fall

07/09/01 02:54:03 PM
by David Penn

Nothing could be finer than a head and shoulders bottom in the SPDRs ...

Security:   SPDR
Position:   N/A

For those scanning the markets for a summer rally, the S&P 500 has thus far proved itself unable to carry the torch. In fact, in the wake of the S&P 500's spring advance (more than 20% from the April Fool's trough to the mid-May peak), the summer has been a bummer with the S&P 500 falling 6% to 1220 early in July.

However, the elusive summer rally may yet appear. In a bearish market such as this, it seems increasingly important to see rallies as the product of corrections. For example, the most powerful rallies in the S&P 500 in the past year, the October 2000 rally, the mid-December 2000 rally, and the April 2001 rally, all came on the heels of significant S&P 500 declines. Using the SPDRs as our trading proxy for the S&P 500, we note that the 9% October 2000 rally came only after a decline in September of 15%. The December 2000-January 2001 10% rally arrived shortly after a 13% decline in November 2000; the most recent bear market rally, the impressive April 2001 advance of 21% was, unfortunately for the longs, the twin sibling of the preceding February-March 2001 decline of 22%.

Figure 1: A test of the spring lows could arrive in the form of a head and shoulders bottom in the SPDRs.
Graphic provided by: MetaStock.
 
A large problem with these rallies is simply that they are occurring in the midst of an overall bear market in the S&P 500. More directly, part of the problem for these bear market rallies is the overhead resistance, which grows greater each time the S&P 500 fails to climb above the 1310 May peak (about 132 in the SPDRs)- which the S&P 500 has failed to do three times over the past two and a half months. The resistance only gets thicker above 1310, as a glance at the S&P 500 chart recalls the congestion of late autumn of 2000, a congestion that looks uncomfortably enough like the present fog.

Looking more long term, and considering the fact that the S&P 500 is entering a correction mode (as suggested in part by the break in the bullish trend in the VIX), it is possible that a correction and rally could complete a head and shoulders bottom in the S&P 500 over the next few months. While the likelihood of such a familiar pattern being profitable in such a closely monitored index may be slight, the bullishness of such a pattern is still worth noting for what it may suggest about the possibility that a bottom is being established in the S&P 500 and that the ferocity of the (a) bear market, (b) earnings recession, (c) recession recession, is finally being put to the test.

The head and shoulders bottom (still under construction) in the S&P 500 consists thus far of a left shoulder stretching from October 2000 to mid-January 2001, and a head that begins with the post-January 2001 decline and ends with the April rally. The current summer correction has retraced nearly half of the head, and would form the right shoulder should the head and shoulders bottom succeed. Success would mean a rally that would take the S&P 500 back across a neckline around 1260 or so, and continue to advance (pullbacks notwithstanding) as much as 300 points on the S&P. The significance of such a sizable rally includes the fact that such an advance would most probably test all but the all time high on the S&P 500 reached on April 2000--the unofficial beginning of the bear market.



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Date: 07/10/01Rank: Comment: Dear Mr. Penn - A head and shoulders top from the May high is perhaps more likely.
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