Another Breakdown

After more than a year of the worst bear market in a generation, you’d think the bears would be getting bored or tired by now, but yesterday’s market breakdown showed they still have plenty of fight left.

So let’s cut to the chase. How low are we likely to go? The good news is that the indexes all broke down out of measurable patterns, which means it’s possible to make an educated guess about the minimum extent of this decline. The bad news is that the patterns that were broken – head-and-shoulders tops – are considered important reversal patterns, so it’s possible that the new trend (in this case, down) could carry prices well beyond those minimum targets.

Let’s begin with the Nasdaq (see chart below). With the head of the pattern at 2328, and a neckline at 2100, the index has downside potential of 228 points below the neckline, which would carry the Nasdaq to 1872, well below the 2000 level that marked its breakout bottom in April (see arrow on chart). The troubling aspect is that trend indicators like ADX, MACD and PPO (see bottom of the chart) are all suggesting that this down move could be a trend, and those indicators have quite a ways to go before they reach the other end of their ranges.

The S&P 500, with a head of 1315 and a neckline of 1240, has downside potential to 1175 from the breakdown point of 1250. That would carry the index below 1200 support, which also marked a breakout.

The Dow, with a head of 11,350 and a neckline of 10,800, could be headed for 10,300 support from its breakdown point of 10,870.

The ISDEX,’s Internet Stock Index, also broke down out of a head-and-shoulders top. With a head of 302 and a neckline of 240, the index could be headed back to the 180 area, just above its April low of 159.

The breakdown is also showing up in individual stocks, which confirms what the indexes are telling us. Of the potential bottoming patterns in leading technology and Internet stocks that we’ve been tracking, only Microsoft is still holding up.

If the indexes reach those targets, it likely won’t be in a straight line. The market is short-term oversold and due to begin a rally in the next day or two (the 2000 level on the Nasdaq or 1200 on the S&P might be a good place to look for a bounce). But the breakdown points of 1240 on the S&P, 2100 on the Nasdaq and 10,870 on the Dow will likely cap any rally. If they don’t, that would be the first good sign that the breakdowns could be negated. And with tame inflation data the last two days, there’s nothing to keep the Federal Reserve from delivering another 50-basis point rate cut on June 27.

But this is only the third market in the Fed’s 88-year history for which rate cuts haven’t been a panacea, the others being 1929-1932 and 1981-1982. That alone should be enough to make investors cautious.

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