Stock Market Topping Formation Update

Last week, we took a closer look at the characteristics and components of the massive topping formation in the stock market. Although this formation is no longer a well-defined head and shoulders pattern, it still suggests that a long-term trend change is in progress and may be entering its final phase. Stocks closed sharply lower this week as the bearish rising wedge formation that we have been monitoring finally broke down, bringing us to another important inflection point. (Click to enlarge)

Aside from the brief plunge down to about 1,022 at the end of June, the S&P 500 index has held above congestion support in the 1,060 area since the cyclical uptrend moved to a new long-term high in November 2009. For the integrity of the rally to remain intact, the index must continue to hold above that 1,060 support level. A second weekly close well below 1,060 would virtually guarantee a move back down to the recent long-term low near 1,022 and substantially increase the odds of a subsequent breakdown to new lows, a development that would confirm the start of a new cyclical downtrend from late April.

From a cycle analysis perspective, we are still early in the intermediate-term cycle that followed the most recent low at the beginning of July. However, the sharp decline this week provides further evidence that a primary downtrend is in the process of reasserting itself.

Notice that the cycles from the March 2009 low to the top in late April were mostly green, indicating a bullish primary trend in progress. However, the violent correction in May and June changed that pattern as the preceding extended bullish phase was followed by a bearish phase of equivalent duration. This type of shift is often a signal that a reversal is in progress. If the current cycle were to have a short bullish phase followed by an extended bearish phase, that transition would indicate that the direction of the primary trend is now down. Therefore, additional weakness during the next few weeks would suggest that the high of the current cycle occurred last week and increase the likelihood of a breakdown to new long-term lows in late August or early September.

We are rapidly approaching the "make or break" point for the cyclical uptrend from early 2009 and what happens over the next several weeks could have a major impact on the long-term forecast. Charts do not always have something important to say, but when they do it is important to listen. Now is a time to listen closely to the message of the market.

Disclosure: No positions