Tops Don't Collapse All at Once

 | Apr 25, 2014 | 7:00 AM EDT
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There has been quite a bit of discussion lately about whether or not we're at a major top. There are many comparisons to the 2000 and the 2007 highs. While I was negative on the markets at both of those highs, I never imagined they would come down as much as they did. To anyone who saw those sorts of declines coming, my hat goes off to you.

What I would point out is that if you are fearful that this particular high in the market could be like one of those two previous highs then understand that in neither case did the market collapse all at once. In both cases we came down in layers. Let's look at the S&P from 2006 to 2009. Notice that the top that developed back then took about a year to form. Read that again: one year.

Now look at 2008. The first half of the year, while not spectacular, wasn't that bad. The S&P enjoyed a 10% rally from the Bear Stearns low in March 2008 until May/June of that year. My point is the decline in the market began in earnest in the summer of 2008, which was nine months after the high in October 2007 and one full year from the peak of 2007's summer.

Let's look at Nasdaq in 2000. That initial whack from the high at 5,000 was quite a collapse to 3,500, but all it did was give up the gains from January and February. Be that as it may, you can see that for most of the year 2000 we range-traded between 3,300 and 4,300. The collapse arrived as we headed into 2001, nine months after the high was made.

Now let's look at Nasdaq today. Yes, the head-and-shoulders top is very clear now, if it works out. But unless and until we break that low just under 4,000 from two weeks ago, this is still a trading range.

There are signs all is not well in the markets. The number of stocks making new highs continues to contract. The S&P is trading just a few points off the all-time highs and there were only 130 stocks making new highs on Thursday. That tells you how hard it is to find stocks that are in uptrends and can make you money.

The McClellan Summation Index has turned upward, but considering breadth has made a higher high, the Summation Index's action is not encouraging. Over on Nasdaq, it is even worse. Over on Nasdaq, a net differential of -600 million shares of volume (up volume minus down volume) will turn it back down. This after a 150-point rally, there simply is very little cushion underneath.

There is also sentiment, which I discussed in full yesterday. The wild swings in sentiment are signs that folks are antsy about the market. They show a highly emotional market, which tends to be a poor backdrop for investing.

So, when I say that I think we can rally again next week into a maximum overbought reading, but that I expect the market will fail on such a rally, it is these statistics I am looking at. The question of how far down we can go is the one folks always seem to ask. I'd love to answer you, but in my three-plus decades of watching the markets I have never seen stocks get crushed the way some have and the indexes stay strong. For example, how many of those Nasdaq momentum names have come down 20% or more and the Nasdaq itself was down barely 10%. And the S&P came down less than 5%.

What we do know is that market players are no longer so keen to chase stocks on the upside and more often than not there is selling into rallies and that is a change from the relentless bid in 2013. If we rally again (as I expect) and the statistics improve, I will be glad to join the bullish crowd. But for now the divergences are plenty.

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