1987 Crash Revisited - $DJIA $SPX $ES_F
Could something like the 1987 Crash happen again? No, not after the various circuit breakers were introduce to prevent a rapid collapse in prices like what occurred on October 19, 1987. Nonetheless, the pattern that led up to this remarkable crash is a very important topping pattern. It was a classic head and shoulders (h&s) topping pattern.
Above you will notice that we have compared the 1987 topping pattern to the pattern currently exhibited in the $SPX over the last few months. Here are the individual charts full sized: 1987 Crash & 2010 SPX for closer inspection.
The first thing to notice is the similarities in both RSI indicators. The double bottom (A wave) and reaction rally (B wave) are eerily similar as of late. Both B waves traced slightly higher then 61.8% of wave A’s decline. These reaction rallies often form the final shoulder of a head and shoulder topping formation. If the pattern is valid, these final reaction moves up suck in the remaining bulls as longs are distributed to them.
Now do you go out and sell the farm and bet again Mr. Market here? Absolutely not! Pushing the panic button is not something that appeals to us. We present it as a possibility. History never repeats itself, but rhymes it has been known to do. Just bear this pattern in mind.
What to look for over the next week or two if this pattern was to fufill:
- The move down will happen very shortly
- We should not exceed the $SPX 1117-20 level over the next 4 trading days
- We need to take out the recent low of 1084 within 5-6 trading days
- We need to take out the wave A lows around 1045 for the breakout to occur
- Volume on the downside will be extremely heavy
- The MACD indicator needs to crossover and turn down
We have been pointing out head & shoulder formations on several major indexes recently. When we notice these patterns we pay close attention to them.
You won’t see the rapid type of collapse that we saw in 1987, but you may see a cascading type of mini-crash we witness in the fall of 2008. It’s just a pattern that we are watching closely and would like to share it.
Head and shoulder patterns have led up to some of the worst bear market declines. Here are some examples:
1957 DJ Transports Bear Market *
(*) - These charts were liberally borrowed from http://www.chartsrus.com/ for educational purposes.
The last shoulder of a head & shoulder pattern, sometimes labeled as the B wave up, is a very deceptive counter trend rally. Investors are lulled into thinking that all is well again. Bulls get sucked in and the weakest bears capitulate and cover. We encourage you not to discount this powerful topping pattern. Be on high alert near the top of the last shoulder. It will shortly resolve itself one way or the other.
There is another pattern we would like to review today. It is the similarities between the 1929 Crash and the 2000 Dot.com Bubble.
2000 Internet Bubble and Aftermath
You will notice that a swift recovery after the 1929 parabolic spike did not happen. The 1930s were plagued with fits and starts for many years. After the bottom was reached in 1932, the DJIA spent 5 years battling back before its next setback in 1937 DJIA Bear Market *. That setback lines up pretty well with 2008 Bear Market on the $NDX above.
If the patterns loosely match one another, we will retest the 2008 lows in a W bottom formation over the next year before the next, real secular bull market begins in earnest. So to us it’s very plausible that we could see a decent correction that that could last 4-10 months. It isn’t an unrealistic expectation.
If you see the ocean tide receding bizarrely, it’s not a good idea to scurry down to the revealed ocean floor to pick up the helpless fish left flopping and other assorted treasures. Be cautious of strange gifts and don’t get sucked into a well designed trap.
