If You Believe in the “Trend Is Your Friend,” You Won’t Like This Chart

business conceptReality is kicking in for the magnificent stock market rally. Key stock indices can only go up so far on hopes, but when hope fades, things can turn sour very quickly.

The selloff on key stock indices over the past couple of days has resulted in technical developments that are worth noting. The S&P 500 has risen significantly since the stock market rally began. Since June of this year, the index has been soaring higher on the hopes of a third round of quantitative easing (QE3), which the Federal Reserve finally announced on September 13, 2012.

In hindsight, the S&P 500 was forming a rising wedge pattern—successive non-convincing highs with a narrowing trading range. The technical chart pattern below is considered to be a bearish pattern that indicates a reversal. The move below the trendline by the S&P 500 index suggests a breakdown and changing of direction.

spx sp 500 large cap index

Chart courtesy of www.StockCharts.com

The recent selloff in the stock market (about 250 points on the Dow Jones Industrial Average in the past two days) caused a break below the lower trendline on the S&P 500.

Will the S&P 500 just break down from here, or will we see the stock market rally continue?

There might be a little bounce to test the same support line that was broken on the S&P 500, but if the irrationality of living off more printed money stays out of the markets, the stock market rally shouldn’t continue.

There are not many reasons for this stock market rally to continue except for a fourth round of quantitative easing (QE4), which is months away.

I’ve discussed the reasons the market is overvalued and simply a “bear trap” extensively in these pages; insiders selling, low trading volume, contracting revenue growth for the S&P 500 companies, the slowest earnings growth for companies since 2009, local and global economic conditions, and increased optimism by the stock market gurus and mainstream media.

As Sir John Templeton said back in 1994, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.” (Source: YTE Magazine, May/June Issue 2010).

If I had to guess, right now, we are at the point where the bull market Templeton referred to (I call it the “bear market rally”) is maturing on optimism—a dangerous place for stocks to be.

Michael’s Personal Notes:

The recession-infested eurozone economies have sent shockwaves of uncertainty around the world. Economic growth is becoming bleak as we progress in this uncertain economic environment. The fear of a global recession is hovering like never before.

For the last 21 years, Australia has not witnessed a recession. Now, with a weak global economy and declining exports to China, the Australian economy—one of the developed economies—is flirting with a recession. The central bank of Australia recently slashed its interest rates to their lowest in three years and hinted about the dangers ahead. (Source: New York Times, October 8, 2012.)

Similarly, emerging markets are seeing weakness across the board. This shouldn’t come as a surprise to my readers. We have been warning you about an economic slowdown in the global economy for some time, and now all the pieces for that event are falling into place.

The Asian Development Bank (ADB) has cut the economic forecast of India. The Bank expects the Indian economy to grow 5.6% in 2012—it previously expected seven-percent growth. The ADB has slashed its economic forecast for the Indian economy by 20.0%—clearly, the weak demand for exports in the global economy is weighing on the Indian economy. (Source: Asian Development Bank, October 3, 2012.)

Similarly, China, the so-called manufacturing hub of the global economy, hasn’t escaped the economic slowdown. The recession in the eurozone countries continues to affect its ability to grow at the rate it has previously grown. The World Bank’s economic forecast suggests that the Chinese economy will only see growth of 7.7% in 2012. In 2011, the Chinese economy grew at the rate of 9.3%. This year it’s growing 17.0% less from the last year. (Source: World Bank, October 8, 2012.) The Chinese economy is facing challenges due to decline in exports, slowing manufacturing, and decreasing local demand.

Other countries in the East Asia and Pacific region are also seeing their economic forecasts being questioned. The reason is the same all over—an economic slowdown in the global economy caused by the recessions in the eurozone that have led other countries to see a decreased demand for exports.

Here’s what growth looks like for 2012, according to the International Monetary Fund (IMF):

— Spain economic growth of -1.3%

— Eurozone economic growth of -0.4%

— Brazil economic growth of 1.5%

— U.S. economic growth of 2.2%

— India economic growth of 4.9%

— China economic growth of 7.8%

(Source: IMF report, October 10, 2012.)

Each of the countries or areas listed above have one thing in common: they are looking at their slowest economic growth since 2009. But have no fear, dear reader; the stock market is rising.

Where the Market Stands; Where It’s Headed:

See my lead story today on the breakdown in the S&P 500 price chart. I continue to believe we are nearing the end of the bear market rally in stocks that started in 2009. This rally should have ended long ago. The Fed’s unprecedented increase in the money supply has only served to delay the inevitable.

What He Said:

“Recipe for Catastrophe: To me, the accelerated rate at which American consumers are spending, coupled with the drastic decline in the amount of their savings, is a recipe for a financial catastrophe.” Michael Lombardi in Profit Confidential, September 7, 2005. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008, long before anyone else.