Are the US Stock Markets in Trouble? Plus Other Asset Classes to Watch Closely
Before I dive into this week’s analysis of the markets, I’d like to remind you that it’s likely to be a highly aberrant trading week by virtue of the upcoming US elections.
Price action could be quite chaotic due to COVID-inspired mail-in balloting and other turbulence, including recent spikes in new coronavirus cases both in the United States and overseas.
As an illustration, let me show you what happened with gold during the November 2016 US election. This is XAUUSD with that election week highlighted:
Prior to that evening, it was generally accepted that Hillary Clinton was well ahead in voter preferences. When the polls did open, it appeared she was pulling ahead. Then around midnight, it was determined that Trump was going to prevail.
Gold shot up on the night of the election and then very quickly plummeted $80 thereafter. This might seem completely random, but governing price patterns always determine price trajectory regardless of the news.
With gold, those governing patterns included a giant double top that could also be viewed as a large descending triangle. Both are bearish and were overhanging the gold price.
Going into that 2016 election, a smaller descending triangle had formed due to the back and forth price action.
Descending triangles are almost always bearish because price touches the support line so many times. Any horizontal line that keeps getting touched will get breached sooner or later. So it was no great surprise that gold fell during the election, albeit with a head fake to the upside before the plunge.
What’s more, this could also happen for the 2020 election.
Here’s the current XAUUSD chart, now on a daily basis:
There’s a new descending triangle here, one showing multiple touches at $1,850 and therefore looking likely to break to the downside.
Prices tend to retreat to where they broke out. In this case, that’s $1,750. So $1,750 is my target for gold once the yellow metal breaks down from its triangle.
So how do you play this anticipated move while keeping in mind any election week volatility?
Since we saw gold jump out of the triangle in 2016 to trap speculative longs with a head face before dropping lower, I’m surmising this could happen again.
So what I would look for is any kind of spike in gold this week and short into that. If gold can jump out of the triangle, that’s likely to be an excellent place to short in anticipation it will drop back into its earlier sawtooth pattern before an even bigger drop to $1,750.
Any such move in gold should affect USDI (the US Dollar Index) too, right?
USDI tracks the dollar against a half dozen of the major most liquid currencies on the planet.
I feel USDI has peaked after a 10 year bull run. This run was marked by a final spike during the height of the pandemic where there was a rush to safety by global investors who crammed into the dollar. After that, the dollar basically collapsed.
I’m still bearish on the dollar for the long term. However, I wouldn't be surprised by another rush into the dollar. That’s due to the bullish key reversal a few weeks back where USDI hit a new low before closing on the high.
That price action seems to have put a floor under USDI for now. I think we're likely to see some short-term strength here over the course of the next few days or weeks.
Now here’s EURUSD (the Euro versus the US dollar) which is an important pair as the Euro comprises more than 60% of the USDI. Often EURUSD is just an upside-down version of USDI:
EURUSD has been in a longstanding bear market and after a brief rally it’s now being pushed back in the direction of the main downtrend.
There were indications of this reversal a couple of weeks ago with an emerging double top. Back then, I said the 1.20 area was likely to be a resistance area that would hold for quite some time as there were bearish key reversals marking both tops.
(A bearish key reversal is when a price bar makes new highs but closes near the low, indicating the sellers are in control.)
EURUSD is now set to go through the neckline of that double top around 1.16. This would place it on a path to retest the 1.12 – 1.14 neighborhood.
Then we'll see if EURUSD collapses in the direction of the major trend or instead recalibrates and finds a way to go higher. Just bear in mind that dollar strength suggests EURUSD is likely to weaken in the short term at the very least.
To corroborate the indications of further dollar strength, here’s AUDUSD (the Australian dollar versus the US dollar).
As with EURUSD, AUDUSD has been in a long-term downtrend. Despite a recent rally, this pair looks likely to turn back into its primary trend before it can recalibrate.
While I feel it’s very unlikely AUDUSD will take out its pandemic low set back in March, lower prices are on the way thanks to the mini head and shoulders that’s just forming right now.
A likely support level would be at 0.66 which is where AUDUSD fell to before its sudden spike lower. At that point, we can see if it starts digging in again.
Continuing with USD-related trading, one pair I’ve been examining for quite a long time is USDJPY (the dollar versus the Japanese yen):
If the dollar is going higher, the one pair that looks likely to buck that trend is USDJPY for the very simple reason. The JPY is even stronger.
The yen has been strengthening over several years and is likely going to continue that trend. This means that yen correlated trading pairs are going to go weaker.
(If this seems counter-intuitive, note that JPY is in the second position (the cross position) in USDJPY and all other JPY pairs. So if the yen’s getting stronger, it means USDJPY is going to drop because USD is relatively weaker to the stronger JPY.)
This applies to all yen trading pairs, of course.
The reason I feel so strongly about USDJPY is because of the number of bearish price patterns going all the way back to 2015 with a double top that formed the head of a head and shoulders.
That pattern has been like a black cloud hanging over this pair and indicating lower prices. USDJPY has been in a bear market for the last five years, including a litany of bear price action within a descending triangle characterized by lower highs and a common low at 104.
USDJPY has hit this common low seven times. But great bull markets are not launched by hitting a common low seven times and giving everybody a chance to get in. So I can’t see how USDJPY is going to sustain any momentum to the upside.
That being said, all bets are off as to what kind of scenario we’ll see in election week. We could see a jump within (or even outside of) the descending triangle, just like a similar scenario could happen with gold.
Just remember the long-term bear patterns suggest the USDJPY trend remains down.
And that’s why you need to stay unemotional -- stay away from being a reactionary trader and keep your discipline. Always keep your eye on the governing patterns. Understand how they direct prices going forward.
Now to drive home my case for the yen pairs dropping over time, here’s EURJPY (the Euro versus the Japanese yen):
EURJPY formed a long-term head and shoulders price pattern, then more recently a double top. Both are bearish.
So the strength of the recent rally in EURJPY was likely not sustainable. This was a counter-trend rally within the context of the main trend, which has been lower prices from 150 to 121 over the last five years.
Another major descent is on the way due to the most recent double top at 126. In fact, EURJPY actually crashed through that pattern’s neckline last week.
Of course, EURJPY could bounce from that drop. But I think this will prove to be a head fake and it will be followed by a continued erosion of prices to the downside.
Another pair likely to offer opportunity in the near term is GBPAUD (the British pound versus the Australian dollar) which has been somewhat of a murky picture. It’s been going up and down and everywhere:
However, the governing patterns indicate GBPAUD is likely to find a higher level overall due to the triple bottom established back in 2016 – 2017.
Since lifting off the floor at 1.55 GBPAUD is trading at 1.85 now, and during that time the 1.75 area transformed from resistance to support.
That support has helped form a neat double bottom and right now GBPAUD is trading at or near the neckline of that pattern.
The path of least resistance indicates GBPAUD will lift out of this double bottom and find some blue skies above 1.85. The background volatility of the US elections could be what puts this into overdrive.
Now here’s XAGUSD (spot silver) as it’s important to review the other precious metal after I began this report with XAUUSD (spot gold):
Going all the way back, a large descending triangle led silver much lower for the next several years. Silver recently broke out of that prolonged bear market by escaping the confines of the $14 - $20 area.
But even after the breakout, silver is still far from its highs Now it looks like there's further pressure to push it down in the direction from whence it came, just like spot gold.
Silver is forming an asymmetrical double top right now. It’s essentially another descending triangle with a neckline at $22. If silver breaks that neckline, it should retest the breakout area.
Be alert for a breakdown in silver and pressure to revisit the neighborhood of $20.
However, the one asset class most likely to feel the reverberations from the election results will be the US stock market. We've had central banks reduce interest rates almost zero, which meant investors had to find a return somewhere. They flocked to the safe haven of the US stock market which catapulted higher thanks to stimulus from the Fed.
And now it's an open question as to whether this is a bubble that’s about to pop ... or not.
Let’s start with the NASDAQ, the proxy for the tech sector within the United States:
The NASDAQ broke out of an ascending broadening price pattern recently.
Since then, price is forming what could be a classic double top price pattern. (Incidentally, the NASDAQ looked just like this in 2000 before the tech sector crashed.)
So are we revisiting that scenario (a spectacular crash in the U S stock market) or will prices find some footing at the top of that ascending broadening formation?
If this really is a double top, anybody who chased this breakout is going to be sorry they did so.
I think there's a very good chance the NASDAQ could crack heavily. On the other hand, yet more stimulus from the Fed and Congress could generate enough support to keep prices grinding to new highs.
However, the strict definition of an ascending broadening price pattern is that it’s a bearish price pattern. If this holds true, it means the NASDAQ could retreat to the bottom of the pattern and even below it, spelling a huge disaster for stock investors.
So it's going to be very important to see if this market can hold up amongst all the volatility that's going to be thrown at it during election week.
Here’s the S&P 500 for comparison:
The S&P has traced out a reverse symmetrical triangle, also called a megaphone top. Coincidentally this is the same price pattern that preceded the crash of 1929.
It's yet to be seen if this will fulfill that particular destiny or if the S&P will instead grab a foothold and find a way to go higher over the next couple weeks. Time will tell, but in the meantime there could be an ominous double top at the 3600 price level.
Right now the price isn’t far away from the neckline at 3200. Any breakdown here would confirm this double top and suggest much lower prices going froward.
However, the stock index that got destroyed the most last week was the (DJIA) Dow Jones Industrials Average:
It’s probably not surprising that this was the first index to break down. In contrast to the S&P and NASDAQ, the DJIA never made a new high above the one it established in January.
It fell short and you could characterize this as a bearish divergence where two indexes make a new high that isn’t confirmed by the third one.
In any event, the DJIA is trading within the confines of a reverse symmetrical triangle (megaphone top). And there’s a lot of room for this market to fall from the emerging double top at 29,000.
The DJIA cracked through the neckline last week, all but confirming a bearish future. I can well imagine that the DJIA could retest that neckline, but if (and when) this fails it should open a path for much lower prices.
So a lot is going to be riding on that during election week. If you're inclined to trade, tread carefully and be aware that huge volatility means less liquidity and wider spreads which means you need to keep your stops very wide and your eyes open.
And that’s it for the week!
I’m bearish on gold and silver, short-term bullish on the USD (and therefore bearish on EURUSD and AUDUSD), bearish on USDJPY and EURJPY, bullish on GBPAUD, and concerned about a potentially major future drop in the US stock markets.
I wish you a very healthy and prosperous trading week.
Mark "StockBubble" Shawzin