Massive Double Top: The Basics

This blog is dedicated to warning America about a possible impending disaster foretold by the stock market, specifically through technical analysis of the Standard and Poor 500 stock index chart.

Two peaks in the index coincide with the largest financial bubbles in history, the tech stocks boom of the late 90s and the housing bubble of the first decade of the 21st century. Between these peaks was a three-year bear market, during which the stock market lost roughly half its value. In technical terms, what is forming is called a "double top," though this would be the largest and longest double top in the history of the world. The ramifications are potentially disastrous for the economy of the United States and the world.

Diagram A: The two peaks

The diagram above shows the tops and the valley between. The S&P reached 1,527.46 in March of 2000, just before the tech stocks boom went bust, driving the index below 800 in late 2002. In early 2003 it began to recover and climbed, over the next four years, to peak at 1,565.16 in October of 2007, but it was unable to significantly exceed the previous high mark. Much of this growth was related to the housing-bubble-driven economic recovery, but as that bubble began to deflate, another choppy decline began. The end result is a chart that forms a massive double top. The double top is even more pronounced when the chart is viewed in linear scale, as in Diagram B.

Diagram B: The double top with linear (rather than logarithmic) scale.

What will happen if the double top behaves as expected? Normally the fall in a stock or index that exhibits a double top is twice the logarithmic length from the Headline to the Neckline. These terms, borrowed from the related Head and Shoulders formation, simply refer to the level of the two peaks and the level at the trough. The index is expected to fall from the 2nd peak to the level of the trough, and then again, in percentage terms, as seen below in Diagram C:

Diagram C: Headline, Neckline, and Logarithmic decline distance.

With the 2nd top at 1,565.16 and the neckline at 776.76, a fall of 50.4%, an additional decline of 50.4% would DROP THE S&P 500 ALL THE WAY TO 385.49. Because the tops and bottoms can be measured various ways (intraday, moving average, etc), in simplest terms the index peaked near 1,600; fell to around 800; and should fall to approximately 400, sometime around April of 2010 (very large declines take 2.5 to 3 years).

This level hasn't been seen in the S&P 500 since October of 1992. In late 1991, after spending most of the year just below it, the index burst through the 400 mark and barely retouched it twice after that before resuming an upward climb. Therefore the 400 level would provide a solid level, and was in some ways the base from which the credit-driven bubble economy expanded in the U.S. (the 80s bull market was credit-driven as well, but stocks had been languishing undervalued for a full decade before that, so an upward correction was in order).

A return to the levels of 1992 in the stock market would require a huge economic decline. A stock market drop of the magnitude proposed (75%) might be half based on fundamentals and half based on overcorrection. The GDP in 1992 was about half of today's level in nominal terms, and about 2/3 of today's in real (dollar-constant) terms, suggesting a 33% drop in GDP, which might be consistent with a 75% stock market crash. But dollar-adjustments and deflation muddle the picture. For historical reference, during the Great Depression, real GDP fell just over 25% while the S&P declined nearly 90%.

Regardless, the outcome will be grim if the Double Top completes itself. To do so, a continued decline forcefully below the neckline must occur. That alone would be a 50% drop, so it's almost academic whether it then continues to drop to the 400 level. If it doesn't forcefully break through the 800 line and drop below the previous neckline, then what we will have is simply twin bear markets brought on by twin financial bubbles. And should the market turn around at any time and forcefully break the previous high set in October of 2007, then the entire chart pattern is invalidated. Until the neckline is broken, there is no reason to believe the S&P will fall to 400. But viewing the charts right now, with the huge spread in years and magnitude of the formation, it's good to know what may be coming and prepare for it just in case.