Some folks are permabulls or permabears. As for me, I am a perma-observer of head-and-shoulders patterns! I don't actually seek these out, but for some reason I seem to see this particular pattern more than most. I am not biased, either, because I see tops as often as I see bottoms.
So you can imagine the argument going on in my head right now. Do I put stock in the smaller head-and-shoulders bottom that has developed over the last month or so, or in the much larger pattern that has developed over the last year?
To me the most obvious chart formation is in that seen in the Nasdaq Composite -- but if you tilt your head just right, you can also see it in the S&P 500 and the Dow. On the chart below I have drawn in the potential Nasdaq bottom with red letters. I have shown this to you before, with the notation that 3025 is a huge resistance level. That's the neckline.
As you'll see, I have also shown the much larger head-and-shoulders pattern, marking in red the left and right shoulders. I showed this pattern about two weeks ago when I discussed an outlook for the first quarter of 2013.
For me it always comes back to the indicators, and the market has been working off that massive overbought condition for nearly two weeks now. I would not consider stocks to be oversold at the moment, but they're at least heading that way. Keep in mind that is short-term in nature -- and also consider that the S&P recently tagged a higher high as the Oscillator made a lower high. In light of this, I am apt to believe that any oversold rally at this point would likely coincide with a lower high in the Oscillator vs. early December.
For one thing, with each push higher in the S&P since Nov. 29, the number of stocks making new highs has been pathetic on the NYSE. That points to laggards rallying -- not leaders leading. But now we're seeing a rollover in the 10-day moving average of stocks making new highs and those making new lows. I suspect we'll see another market-rally attempt before the end of the year, rather than an immediate tumble from the rollover -- but the general direction is no longer bullish.
The McClellan Summation Index has stalled. It is not yet flashing a bearish reading. But if the market doesn't have a solid rally soon, it will begin to roll back over.
What keeps drawing my attention, however, is the 30-day moving average of the advance-decline line. This indicator is essentially an intermediate-term Oscillator -- and, oddly enough, it will reach a maximum-overbought reading on the first day of the new year.
So, in the intermediate term, there is still some room to rally into year end. The shorter-term Oscillator, meanwhile, is likely to set up some kind of oversold reading in the next week. So my sense is that, regardless of whether the shorter-term head-and-shoulders bottom pans out, the bigger top will come into play sometime in early January. That doesn't mean the market has to slide the first trading day of January, but it probably means any potential fiscal-cliff deal -- or, for that matter, a lack thereof -- will be a sell-the-news event. The only thing that would change my mind here would be an explosion of stocks making new highs, and right now that doesn't look likely.