From Inverse Head and Shoulders Breakout to Head and Shoulders Breakdown?

Submitted by Mark Hanna

Courtesy of MarketMontage. View original post here.

Before we get to any technical patterns first the topic of the day/week/quarter – fiscal cliff nonsense.  My inclination over the past month has been they would most likely kick the can until just after Jan 1 so that the GOP can “cut taxes” once they go up in the new year.  (i.e. get a deal done before the first major payroll period mid January)  However, some of the commentary this weekend has me a bit more worried that it would be that easy.  Some are talking about jousting going on all the way until the debt ceiling, which if accurate, would be a big mess indeed.  For while the fiscal cliff is a bit hyped up – more like a fiscal slope – (and very self inflicted) we saw last year what the fiscal cliff situation is.  There is a drop dead date for that one and with the dysfunction we have in government, the prospects of anything being done seem dour.  

Even today as they talk about a last minute “solution” – which in many ways should upset people more, if it happened in the last hours of the year, than if the can was kicked – there is no talk of spending cuts at all, it’s all “push it out to 2015” talk.  Which is of course why no spending cuts were done in 2010 (push the “Bush tax cuts” out two years), or last year, or frankly at any point.  It appears until the day there is market pressure (could be in 5 years could be in 20 years) only status quo with a lot of window dressing on the margin will be the name of the game.  But in a way you cannot blame politicians – this is how there incentive system is set up and as we showed a few weeks ago, Americans want to “cut the deficit” (in theory) as long as it doesn’t require anything that affects their lives.   Which of course is an impossibility.  So as dysfunctional as government is, the people are fine with the arrangement, only complaining in public polls while re-electing most of them.  (part of this is due to gerrymandering of course as well)   As for the “this is not a good time to (a) raise taxes or (b) cut spending” well there is NEVER a good time.  Either “the economy needs more help to get it out of the doldrums” OR “we don’t want to risk slowing down a good economy” will be offered as the reason – and those are the 2 main conditions the economy is always in.

Anyhow the larger point here is once this impasse is “solved” we just move onto the next.  Which is the depressing part of it all.  Either the can is kicked for a few weeks so we reconvene in February on the debt ceiling, or nothing is kicked and we have this self inflicted mess through the debt ceiling.  None are good options although the market will react in Pavlovian fashion to “anything” that is not viewed as immediate damage.

Futures are “up” as I type but not up at all.  After the close Friday the market’s took a battering in the after hours session as the 3 PM meeting some believed to be a Hail Mary proved to be nothing but “optics”.  So futures are only up from the damage done between 4 and 5 PM Friday after the close.  At the worst of it the S&P 500 was down some 4% from peak only seven sessions ago.  So we have some serious intermediate term damage done to the technicals now and the potential inverse head and shoulders formation has failed, and we instead have the potential for a much more damaging head and shoulders formation.  See below.  Recall two failed attempts over the early November highs, marked with the horizontal blue line.  Now the “head” that has been created in early fall, with a left shoulder in early Spring, and the right shoulder just formed.  Of course this not does not preclude the Pavlovian “relief rally” bounce from any deal – in fact there is now a series of gaps that need to be filled to the upside since we’ve had so many gap downs in the past week.

The bearish head and shoulders pattern is more symmetric, if you will, on the NASDAQ.  This chart is especially troubled as not only do you have a declining 50 day moving average but a flattening 200 day.  If that longer term average begins to turn down it will be a highly cautionary signal.  If these patterns play out, there will be great irony in the second David Tepper call – we could be calling it the “Tepper Top”.  We shall see.

On the positive side – and we’ll see how long this divergence can continue – indexes in Europe are doing relatively well, and the Chinese and Japanese stock markets have been rip roaring the last month; the former due to a hope for a bottoming in economic data and the latter due to a new leader (same as the old leader) who wants the Bank of Japan to act Bernanke-like.   To that end some better Chinese data overnight:

• Activity in China’s vast manufacturing sector hit its fastest pace in December since May 2011, a survey of private factory managers showed, with a sub-index for new orders pointing to continued strength in the new year.  The final reading for the HSBC Purchasing Managers’ Index rose to 51.5 in December, well above the preliminary reading of 50.9 published in the middle of the month and November’s final reading of 50.5.
• The HSBC PMI rose above 50, the line that demarcates accelerating from slowing growth, in November for the first time in more than a year.  A sub-index tracking new orders showed even more room for optimism, rising to 52.9, its highest level since January 2011.

As for the U.S. the first week of the month is always the big week with ISM Manufacturing Wednesday (last month was a contraction at 49.5 vs 51.7 in October), ADP Employment Thursday, the government’s employment data Friday (consensus +157K versus last month’s +146K), and ISM Non Manufacturing (54.7 in November).  PMI data in Europe will also be released.

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Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog