How and Why the Stock Market Could Drop 15%
Before I analyze more conventional price charts for the week, I want to address the potential boogeyman in the room for gold investors and stock investors.
And that's the silent threat of rising interest rates. This is the 10-year US Treasury Note interest rate:
Starting with a double bottom around half a percent in the early 2020 timeframe, the 10-year Notes have been steadily ascending from half a point to over 1.3%.
While the Fed keeps saying they want to keep their interest rate policy at zero, market forces are starting to impact the Treasuries.
It seems that as inflation is picking up across the board, gold’s go up, oil’s going up, lumber’s going up and copper’s going up. Yet once the threat of inflation rises, the market starts demanding higher rates of return. The 10-year Notes are now returning 1.34% and almost 2% on the 30 year.
That means these rates of return are starting to compete with stocks and certainly gold, which doesn’t offer any rate of return at all.
I’m surmising that if we get to 1.5%, there will be a tremendous dislocation in the stock market because stocks have been rising predominantly on the basis of easy money and low interest rates where investors couldn't get a return on bonds.
Instead they sought that return in the stock market. Now we're starting to see a risk-free rate of return that’s becoming more competitive . It’s likely to create a dislocation in a number of markets including gold and certainly stocks going forward. So it’s something to keep an eye on.
Watch the 1.5% return benchmark, because that’s where I believe it would start creating some dislocation in the market.
But before I focus on what's going on in the gold market and the stock market, I want to bring your attention to a curious pattern I found several months ago in GBPAUD (the British pound versus the Australian dollar):
There are some similarities with a pattern in GBPAUD versus gold and the stock market. Namely, an ascending broadening price pattern which starts very narrow and then broadens toward the top.
When GBPAUD’s price broke out of that pattern, this presented a major selling opportunity because by and large, these ascending broadening price patterns are bearish. Once they breach the lower end, we can come up with a defined price target objective: the base of the original pattern.
And that's exactly what happened. After prices rose to 1.96, they plummeted to 1.75.
What’s more, GBPAUD just had a bearish week with a key reversal not far from another top – that’s where earlier in the week prices went higher but closed on the low at the end of the week.
This has created a mini double top with two key reversals. So it looks like there’s going to be further downward pressure on GBPAUD in the week going forward.
Now I want to direct your attention to the same ascending broadening price pattern in XAUUSD (spot gold):
For the past several weeks, I’ve been maintaining that gold is trading within the confines of an ascending broadening price formation which will very likely bring gold down to the $1,650 - $1,700 target level.
That will likely be a major inflection point. Either the market will bounce or -- if it breaches that lower level -- then gold is going to the base of the formation at around $1,150.
This is why I only focus on price patterns and price action analysis, because movements in gold have typically been very emotional.
Everybody’s been buying based on central bank easing, negative yield bonds and things of that nature, but the price chart is flashing warning signs that the yellow metal is going lower in the short term and perhaps a much lower over time.
So I would sell into any rally in gold with the view that we're going to crash to the $1,700 price level before much longer.
Now I want to continue with this theme of ascending broadening price patterns with the NASDAQ stock index.
There are different characteristics as to how this market traded within its ascending broadening formation: instead of crashing at the trigger point at the upper end of the pattern like GBPAUD, the NASDAQ instead used this as a pivot point to new highs.
So that's why you can’t look at these price patterns in a vacuum. After you put a structure around price, you need to observe how price actually performs within the structure.
Note the multiple bullish key reversals along the support line of this ascending broadening formation. Every time the NASDAQ made a new low, the price reversed and closed on the high.
Ironically, the NASDAQ has carved out a second ascending broadening formation which is a bit easier to see on the daily charts (we’ll get there in a moment).
Price continued rising until it traced out a bearish key reversal. Despite the NASDAQ making all-time highs last week, it closed on the low of the bar. This means the sellers were in control by the end of the week.
Now it might be a bit too early to call this yet. We may have one more bounce to the upper end of the new ascending broadening formation. But I do think that we’re close to a trading apex which will lead this market lower.
If so, the NASDAQ should retrace to the base area of the new formation at around 11,500.
However, there’s a way to go before anything like that happens. The first objective is to see if price actually exits the formation. It could very well bounce off and resume trending higher as it did in the original formation.
But I do get the feeling that we’re very close to what could be a tradable top that will lead to a 10% - 15% decline before this market starts going back up again.
And that’s the beauty of price patterns: we've looked at ascending broadening price patterns in GBPAUD, spot gold and the NASDAQ. These patterns trace themselves out across all kinds of trading instruments. It doesn’t matter if you're trading cocoa futures or T-Bond futures or gold or the NASDAQ. You can still make trading decisions based on observable price action and price patterns.
Now let’s take a closer at the NASDAQ with a daily chart where each one of these price bars represents one 24-hour session.
The most recent ascending broadening formation is more discernible now.
You can also see the key reversal at the top a few days ago, then on Friday there was an inside bar where the range from high to low was literally within the range of the previous day.
Such inside bars represent a coiling of energy which then gets released upward or downward by virtue of prior price action or the governing price pattern.
I feel we’ll certainly test the lower edge of this new ascending broadening formation around 13,000. And should the NASDAQ breach that, prices will very likely retreat to the beginning of the formation and possibly even lower.
So I'm watching the market very closely within the context of this pattern.
In the interests of full disclosure, I started getting long QQQ puts last week (QQQ is an ETF acting as a proxy for the NASDAQ). By buying puts, I’m betting on the downside in the next week -- a very dangerous bet because what I'm expecting has to happen right away.
Otherwise I could lose all the money at risk in the puts.
But I'm going to show you a better way to play this. One where you don't have to risk that much.
Here’s the SQQQ, which has an inverse relationship with the QQQ:
That means this ETF goes lower when the NASDAQ goes higher and vice versa.
SQQQ is at the narrowest part of the triangle I’ve drawn here. If the NASDAQ does break down, then SQQQ is going to get a nice bounce.
There’s also a few subtle key reversals in the current compressed range, so this looks very likely to pop. I suggest putting in a buy stop above the 12.59 high from last week.
This is NOT a great long-term bet, but if the market powers out of here, prices are very coiled and energy could be released with a vengeance. At current levels, you could risk $1 in this ETF to perhaps make $5 and I'll do that every day and Sundays.
So this is a nice way to play the stock market if you expect a decline in prices.
One individual stock I'm looking to go lower no matter what the overall market does is Beyond Meat (BYND). The company produces a meat substitute but I’m most interested in its very bearish chart:
Prices look like they're going to go a lot lower here. Before the recent short squeeze, BYND was tracing out a double top as part of a broader head and shoulders.
I got caught in the short squeeze from around $150 as the stock went to $218 at its highest.
But I hung onto my position and I expect it to be profitable quite soon. In fact, I made a bunch of money buying puts over the last week and I’m actually over breakeven already.
That’s because I believe the huge key reversal at the peak is the first of two tops forming an asymmetrical double top. This should be the governing pattern going forward and should lead to lower prices.
The company announces earnings on February 25th. Earnings can be a very risky bet, but the price action in BYND is pointing lower. If you have an appetite for this kind of aggressive play, then it’s worth betting on the downside in the short term and possibly even the long term as well.
Now here’s GBPNZD (the British pound versus New Zealand dollar):
I've been advising members to buy GBPNZD thanks to the double bottom which should act as a reversal price pattern that would lead prices higher. It may still come, but on Friday GBPNZD closed very badly.
The pair closed on the low of the day and took out the previous day's low. So it's going to be intriguing to see whether GBPNZD holds and goes back up … or if it continues in the direction of the downtrend on this chart.
Because of that uncertainty, I suggest you get out of your long positions here. It's basically a breakeven from where I got in. Let’s reevaluate prices next week.
That double bottom could still be the governing price pattern, of course. If GBPNZD can hold just north of 1.88 (critical support), then the double bottom is still the way to bet.
But if we breach that level then GBPNZD is likely going lower.
I'll be looking to reenter based on whichever price action we see. And we should know within the next few trading days if Humpty Dumpty can put himself back together again or not.
For now, I’m going to the sidelines to just watch. I’ve also been examining the yen trading pairs for the last several months, particularly EURJPY (the Euro versus the Japanese yen) for indications of a paradigm shift in the market:
By and large, this pair has been in a very long-term downtrend and still is. But if prices perk up a bit more and take out 130, then EURJPY could turn around from a downtrend into an uptrend.
There’s a symmetrical triangle here and EURJPY isn’t far away from a major resistance area that would either be a catalyst for a breakout or a turning point back in the direction of the major trend.
Price patterns suggest it's the latter since the head and shoulders and double top remain place and still act as governing patterns.
Even though short-term momentum is still higher and could go as high as a false breakout beyond the trendline, I feel EURJPY is ultimately likely to turn around in the end.
I think we could be close to that inflection point now.
Here’s the daily chart in EURJPY with some evidence for that idea:
Each one of these price bars represents one 24-hour session. EURJPY has been hugging its uptrend line and recently broke above this resistance line.
So there’s an ascending triangle with resistance around 127.50.
EURJPY broke above that resistance level but is now settling back inside the triangle. This suggests that breakout could be a bull trap where the bulls who chased higher prices are going to be trapped. If EURJPY turns they could be in a lot of trouble.
I'm seeing signs of a potential turn in the form of key reversals and also inside bars creating a coil.
A coil represents stored energy which will be released in the direction of the trend or countertrend. I'm surmising by virtue of the long-term patterns in the previous chart (and a potential bull trap on this one), that EURJPY could surprise the market with a release lower.
If and when EURJPY drops below that ascending trendline, prices could plummet.
So I think there's a sneaky bet to be made here: put a sell stop under Friday's low around 127 and see if the price comes running to you. If it happens, that could open the way for a nice move lower.
Now here’s the daily chart of USDJPY (the US dollar versus the Japanese yen):
I'm very bearish on USDJPY based on the price action and price patterns on the monthly, weekly, and daily. There’s a double top in place and USDJPY has been in a long-term descending triangle.
USDJPY just broke out above the long-term trendline (just like EURJPY) but I feel this too could be a bull trap.
You could try shorting it from current levels with a sell stop at 104.50.
But if you're less aggressive, any move back into the descending triangle would also work. The support level for the triangle is about 102 – 103 level and once that level is breached, USDJPY offers a great selling opportunity in advance of what should be much lower prices over the long-term.
In the meantime, we have what looks like an emerging double top and I expect that to be confirmed by near-term price action.
One last FX note …
Based on the predominant bear price patterns inherent in USDI (the US Dollar Index), I’m very bearish long-term on the US dollar.
To my mind, the best bet to play this is AUDUSD (the Australian dollar against its US counterpart):
This is a weekly chart and AUDUSD is tracing out a very aggressive bullish price pattern in the form of an inverted head and shoulders. As I’ve commented in previous reports, the interesting thing about this particular pattern is that the right shoulder is sitting above the left. This means the neckline (simply a line drawn through the pattern) is a sloping neckline.
This suggests that AUDUSD is not just going higher, but much higher very quickly. And that's what we've seen already, starting with the key reversal a couple of weeks ago. AUDUSD bolted to new highs.
AUDUSD is now at a resistance zone between 0.79 and 0.81. But this is a pair that all traders should have a small position in, because I feel there's nowhere to go for AUDUSD but higher.
Because of that resistance zone, there could be some backing and filling here. But I would use every dip to get long and look at holding this for the longer term.
In fact, I fully expect that AUDUSD will eventually go to parity (1:1) with the US dollar from 79 cents right now.
Let’s finish up by looking at XAGUSD (spot silver):
I'm going to start with the monthly chart because looking at the longer timeframe is very informative.
We're only a bit more than halfway through the month, but you can see we made a new high in February.
How do we close? It's very important how a market closes relative to its high and low. That’s because the close will help us determine if silver is going to consolidate before eventually running higher … or if we’re about to see a reversal.
So keep this monthly chart in mind when making decisions in your silver trading.
Side note: To avoid most of the risky volatility associated with XAGUSD, the iShares Silver Trust ETF (SLV) is trading for about $25 and lets you establish what might be a better risk/reward opportunity in silver than the spot metal contract.
Earlier in this report, I started that gold is going lower and perhaps a lot lower.
Many people believe silver should subsequently do the same thing, yet that's not necessarily true. The two most popular precious metals can and do become untethered with each other.
It happened late last year when gold separated from silver and went to its highest price versus silver in history (the gold-silver ratio went to about 120).
Now that ratio is coming down to earth: it's about 60 - 65. It’s been a lot lower historically, which means that gold can continue to go down and silver can continue to go up.
That’s why you have to treat each instrument separately with its own risk/reward parameters.
Objectively looking at silver, I would say this market has to go higher by virtue of the inverted head and shoulders on the weekly chart:
Once XAGUSD breached the neckline around $20, it traced out a double bottom around $22 and prices have been going higher once again.
Now there’s a coil forming. The trading range of the last two weeks has remained within the trading range from three weeks ago. Like all coils, I'm looking to see how the price action releases from here.
The longer silver coils and doesn't go down, the more likely it’s forming a base from which to move higher.
But if that coil fails in the other direction, we could retest recent lows instead.
So right now there's a lot of uncertainty. That’s why I’m keeping one eye on the monthly chart to help me determine the most likely trajectory going forward.
Sometimes you just need to sit back and wait.
Remember, we don't have to trade through everything. We can just let the market give us more information when it’s ready.
Even if we have to buy it higher, at least we’ll have more information backing that decision so we can make an appropriate risk/reward determination.
And that’s it for the week!
To summarize: I’m bearish on the NASDAQ thanks to the specter of rising interest rates in 10-year US Treasury Notes and certain price action. I’m bearish on BYND as well as gold. I’m turning bearish on EURJPY and USDJPY once again. Meanwhile I’m on the sidelines for GBPNZD and silver as either one could go either way. And I’m very bullish on AUDUSD.
I wish you a very healthy and prosperous trading week.
Mark "StockMarketRollOver" Shawzin