SPECIAL REPORT: Stock Market Crash of 2012 in Progress Now!

High Risk of Near Term Global Financial Market Crash

At each juncture, I look at the available information as represented in the market price and technical data.  I approach the body of evidence without preconception and with an open "beginner's mind".  I see what I see.  I analyze.  I develop a set of probabilistic outcomes and then rank them. Then I write my report.  I simply report my findings.

There is an extraordinarily high risk of some variety of global market panic in the relatively near term.  In fact, I would say that there is a extant setup that is as perfectly aligned for an extreme market event as could be dreamed of by the most bearish of permabears.  I'm no permabear, but a thorough review of the current price and technical charts has revealed an inordinate confluence of data points which collaborate to represent a very high risk profile.  The current extreme risk profile is amplified by a nearly total lack of recognition on the part of market participants.  A deflationary episode, potentially on the scale of the 2008 event, is presently on the table.   Investors would do well to at least consider the facts, analysis and conclusions of this report.

(NOTE:  Click the charts to see the full size images)

1. BULLISH CONSENSUS

I generally place Sentiment and Psychology at the bottom layers of my analysis since it it the softest and least reliable data to consider, but in this case I am going to lead with it simply because there appears to be not merely a significant gap between perception and reality but apparently a widening chasm.  Bulls are repeatedly citing "excessive" or "extreme" Bearishness as a primary basis for an ongoing Bullish outlook, but the evidence strongly suggest this view is not only not warranted but that the exact opposite conditions prevail.

There appears to be nearly total complacency in the present market environment.  Few if any analysts are currently willing to consider a market top of any kind, much less a crash.  The continued bold bullishness of the overwhelming majority is simply not supported by the technicals of the market.  Fundamentalist idealists are engaging in delusions of Bullish contrarianism in an environment of a nearly total bullish consensus.

Of late many Bulls are citing American Association of Individual Investors poll data which they view as proof positive of extreme bearishness in the market.   First, let it be said that this data is soft and its interpretation is highly subjective and as such it is rarely useful and its best use comes when one side of the market is leaning heavily on its perception of the data to justify its market position.

Let's have a look at the current AAII data.  Theoretically,  a reading of 25% bulls and 43% bears tells us that most individual investors are bearishly aligned and therefore out of the market or short, setting up a bullish resolution.  Let's backtest that a little:


In late May of 2011 there was a reading that exceeded the current poll.  While it did mark a short term bottom and a sharp rally ensued (and the current setup could be similar), it was very brief and was immediately followed by a market crash.  At the 2007 top, there were multiple readings which exceeded the current poll and yet that turned out to be a spectacularly good time to be Bearish.  In 2008, just before the main leg of the crash, there were readings which exceeded the current poll and yet that was certainly a time when the smart money was Bearish.  It only took a glance at the actual data to discover that drawing a long term Bullish conclusion from a single week's AAII polling data is entirely unsupported by the facts.

Before basing an entire market view on erroneous conclusions about soft, spongy, interpretive data, one might also want to at least look and see if there is at least some supporting, corroborative data.  I did, and there isn't any.  In fact, the exact opposite appears to be true.  Other similar sentiment data appears to suggest excessive Bullishness in the market at this juncture.

Investor's Intelligence Bull/Bear ratio remains relatively high with a slight increase in Bulls and a sharp drop in Bears to very low levels:

In addition, the percent of II respondents calling for a Correction has surged to a 12 year high as the percent who are Bearish has dropped to levels seen at the 2007, 2010 and 2011 tops:


In this context those calling for a Correction are in fact long term Bulls who are looking to buy this dip.  For the contrarian, this can be interpreted as a strongly Bearish setup.

National Association of Active Investment Managers poll surged to over 60% bulls last week and increased yet again this week:

Consensus Inc survey is certainly in the sell zone:

Market Vane is at levels far more correlated with significant tops than bottoms:

Hulbert Stock Sentiment is closer to its Bull extreme than its Bearish extreme:

Now let me be clear.  I am not basing my Bearish market view on this sentiment data.  I am merely pointing out that, contrary to current popular perception, sentiment polling data supports a Bearish rather than a Bullish view.  Generally speaking, when one side of the market is casting desperately about for a life preserver to keep from drowning in their own entrenched, invested view, sentiment polls are the quite often the flotation device of choice.  When they choose to cling to the only ring that is marked with their preferred view, refusing to even look at the others, this is strong evidence in support of a contrarian case for the other side of the market.

A survey of the financial news media and popular blog sites also reveals very little in the way of bearish psychology.  Few if any are calling a top of significance while some grudgingly admit the possibility of a "pullback" or "correction".

2. BEARISH ASSET ALLOCATION, LOW CASH

A little more digging into the AAII data shows that the same investors who are supposedly "extremely bearish" have allocated assets in a pattern that closely resembles that which has been found at important tops:

Stock allocation is at the same levels found immediately preceding the 2008, 2010 and 2011 crashes and only slightly below levels found immediately preceding the 2001 and 2002 crashes.   Investors were similarly allocated to bonds just prior to the 2010 and 2011 declines.  Cash allocation is identical to that found at the 2007, 2010 and 2011 tops and only slightly higher than that found at the 2000 top.

Rydex fund asset distribution data corroborates the AAII data:

Available cash in Money Market funds is nearly at a 3 year low.  Rydex Bull fund allocation is hovering near the highs while Bear fund allocation is at the lows.  Total assets in all Rydex funds is falling as money exits the markets.

Rydex asset ratio also corroborates the AAII data.  It has surged to the bullish side recently to levels above the 2011 highs and is at levels far above those found at the 2007 and 2010 tops:

It appears that market participants have clearly chosen to view the recent decline as a buying opportunity and show no sign of fearing a significant bearish turn in the markets.  This smacks of late bulls desperately seeking an entry point at the top of the market, trying to make up for having missed the big run.  In light of the technical analysis I am going to present to you in this report, this behavior may represent a dangerous misalignment with reality.

Much ado is currently being made of equity Mutual Fund outflows and Bond fund inflows. In my view the evaporation of public interest in stocks in the current environment is not bullish.  Bulls argue that this means that the public is not invested and therefore represents latent buying power on the sidelines. While this may be true in the context of a healthy bull market, we will see later in this report that this market is not technically sound.  In this context the flight of public capital from the markets represents a dearth of available cash, not a surplus:

Mutual Fund cash is at all time lows.

The available cash sitting on the sidelines in money market funds ready to be deployed is near record lows:

In the context of a bullish consensus coupled with a technically weak market, this is a very dangerous situation. Any unexpected market dislocation could result is a free fall with little in the way of sideline cash to stop the fall.

The 200 EMA of Total Market Volume peaked on the first decline of the 2007 bear market:

It has been declining steadily since then.  Declining volume during the 2007-2009 bear market was not Bullish.  

Even downside volume slipped during the 2007-2009 decline:

Upside volume is now at levels seen in 1997:

How does the behavior of market volume during the current Bear market compare and contrast with prior bear markets?

As we can see, volume on the Dow has fallen off a cliff since 2007 and since 2009 volume has come in well below the 50 Quarter EMA.  Volume declined in every quarter sequentially except in the down quarters during major market pullbacks in 2010 and 2011.

During the 1966-1982 bear market, volume stayed well above the 50 Quarter EMA and even managed to expand during the course of the Bear, with periods of higher volume during Bullish phases and lower volume during Bearish phases, the opposite of what we have seen during our current market.  As the Bear neared its end and began to enter a new Bull, market volume began to expand dramatically, doubling as the Bull began its run.  That's the opposite of the behavior we have seen in the present market.  It's well known that the public fled the markets during this period, much as they have during the current phase, and famously the "Death of Equities" was declared.  A dramatic drop in public participation was bearish then, until the bear market ended on expanding volume.

During the 1929-1932 Bear market, volume fell dramatically during the Bear as investors fled the market.  During the early stages of the new Bull, volume in excess of the 50 Quarter EMA came almost exclusively during big rallies and Bullish phases with very low volume during Bearish phases.  Again, this is quite distinct from the behavior we are seeing in the present market.

Historical precedent does not support the thesis that low volume and investor flight is a sign or condition of a nascent Bull market.  

3. COMPLACENCY TURNING TO FEAR

VIX has broken out above the neckline of an inverse Head and Shoulders formation and is poised to move above its 200 EMA:

If the breakout is successful, the extended left shoulder and brief right shoulder suggest a very strong move to the upside.

21 Day Put/Call Ratio is putting in a pattern identical to that which occurred around the 2007 top:

4. PENDING BOND BLOW OFF

The same bulls who rationalize equity Mutual Fund outflows also point to Bond Fund inflows. Indeed, the Total Bond Market ETF is trading at all time highs:

Percent of NYSE Stocks Above the 200 Day Moving Average is showing a series of long term divergences:

While the market has gone on to make new highs, the indicator has not and is currently poised at a neckline of long term support.  Sharp breaks of this level in 2010 and 2011 resulted in panic selling.

One of the outstanding characteristics of all these divergences and non-confirmations is that they are entirely invisible to the overwhelming majority of market participants.  In spite of the fact that the technical divergence is to the field of Technical Analysis what the potato is to Irish cuisine, I have yet to see any recognition by other technical analysts that they exist in this market.

6. 2011 FRACTAL ECHO REDUX

Markets are currently set up in virtually the exact same technical configuration as they were prior to the 2011 crash.  2012 appears to be a nearly perfect fractal echo of 2011.

Follow the numbered sequence:

In 2011, as the market topped in February investors began to allocate to the perceived safety of dividend paying Utilities stocks.  The uptrend in the Utilities to SPX ratio accelerated and spiked as stocks crashed.  The exact same scenario is playing out right now:


There are many, many more nearly identical comparisons that could be made between the 2011 and 2012 setups, too numerous to post. I suppose people think that lightning can't strike twice, but in fact the fractal echo is one of the great edges that the astute trader can use to stay on the right side of the markets.

7. UBIQUITOUS YET INVISIBLE HEAD AND SHOULDERS FRACTAL

Virtually every price chart and many technical charts are showing clear Head and Shoulders patterns on both the intermediate and long term time frames.  I've already shown some above.  Since it's so easy to see this pattern, bearish market novices tend to fixate upon them as proof that "a big crash" is coming. When they are popularly recognized they tend to be contrarian setups. In this case, despite the nearly ubiquitous presence of clearly defined H&S formations, I have yet to encounter a single analyst who has recognized their existence. This is particularly significant since, at this very moment, the necklines of many of those formations are failing badly.

SPX futures:

Note that it is also gapping below the March and April lows.

Nasdaq 100 futures:

Dax futures:

Nasdaq Global Market Index:

EuroDollar:

Nikkei:

Here's a spread of world markets, many of which are currently breaking down from intermediate term Head and Shoulders tops (or otherwise failing badly from very bearish setups):

There are many, many, many more. Look around and you can't help but spot some on your own.  The Head and Shoulders fractal isn't an elephant in the room, it's a herd of elephants!

Aside from INDU and SPX, the only markets to make higher highs in 2012, the overwhelming majority of world markets are also showing long term Head and Shoulders topping patterns, some of which began forming as early as 2009:

Nasdaq Global Market index shows a clearly defined pattern.  Some of the technical features which support the validity of the formation is the weekly RSI divergence at the 2011 high, a perfect 61.8% Fibonacci B wave/right shoulder retracement of the A wave, perfect alignment of Fibonacci time zones at tops and bottoms and a perfectly flat neckline.  The top of the right shoulder is itself and Head and Shoulders top.  There is the threat of an immediate crash through the clustering long term moving averages.

World Leaders Index is also showing a well formed long term Head and Shoulders top.  Some of the technical features which support the validity of the formation include a perfectly parallel rising bear channel, deep violation and impending triple bear cross of the long term moving averages, Fibonacci time zone correspondence at highs and lows and a perfectly flat neckline.

The most incredible feature of both the intermediate term and long term Head and Shoulders patterns now ubiquitous and activated in world markets is their total invisibility to the eyes of virtually every market participant everywhere.  It requires a surreal effort of personal and collective willful ignorance to achieve this magic feat and it stands as confirmation of the overwhelming, entrenched Bullish consensus present at this time.

8. MAJOR BEARISH TECHNICAL BREAKS IN PROGRESS

Whether breaking down through the neckline of Head and Shoulders patterns, losing the support of moving averages or failing at key price support, virtually every price and technical indicator you could care to look at is either poised to immediately fail bearishly in a big way or is in the process of doing so right now.   I've already posted numerous charts above which meet that criteria. Here are more:

Spain is breaking its 2009 low:

Italy is taking out key long term support on its way to its 2009 low:

Dow Jones World Index has broken down from a Head and Shoulders pattern and is now trading well below its 200 EMA and the October 2011 high:

World Leaders Index has broken down from a Head and Shoulders pattern, violated its 200 EMA and lost a support zone consisting of the October 2011 high, early 2011 lows and April and November 2010 highs:

Semiconductors sector ETF has broken its Head and Shoulders neckline and simultaneously lost support of its 200 EMA and the October 2011 high:

Crude Oil has dropped through the bottom of its bear channel and straight through its 200 EMA to begin its Major C wave down.

Commodities Index has lost key horizontal support to start its Major C wave down:

Gold has broken from the precipice of its Major C wave down violating long term trend and horizontal price support and moving well below its moving averages which have rolled over and crossed bearishly:

US Dollar is set to move back above a very long term support/resistance level after a lengthy consolidation. Dollar rallies are generally linked to asset market plunges:

Treasury-EuroDollar Spread (TED) has been consolidating and is ready to start a new leg up:

Emerging Markets have broken trend and the moving averages are ready for a triple bear cross:

European Financials are losing major long term support and are set to violate the 2009 lows:

In summary, virtually everything everywhere is poised for or in the process of strong bearish, significant breaks simultaneously, right now.

9. ELLIOTT WAVE MAJOR C WAVE DECLINE

The rally off the 2011 lows produced one of the most obvious and classically formed "B Wave" patterns ever seen.  There can be little doubt that global markets are currently beginning a Major C wave decline.  In Elliott Wave terms, a C wave decline in a bear market is almost always the most aggressive and deepest segment.

US big caps were the only global markets to make a higher 2012 high, which under Elliott Wave is a common feature in a corrective ABC flat:

Note that the Bull phase that began in 2009 ended and the current Bear phase began in February 2011.  This is abundantly clear if you study the wave counts of markets outside the US big caps.

Dow Jones World Index:

There are absolutely no Bullish impulsive wave formations or characteristics present anywhere on the charts of any market since at least February 2011.

10. CONCLUSIONS

There is simply no question whatsoever that the overwhelming weight of evidence indicates a strong potential for a near term crash of world financial markets.  Certainly, there are many times when latent potential is not realized.  But when this many factors all coalesce SIMULTANEOUSLY in an environment of psychological and emotional complacency and, frankly, sheer ignorance, then the probabilities become heavily skewed towards a realized bearish outcome.  Global financial markets are currently in a bona fide crash window and panic events similar to the 1987, 2008, 2010 or 2011 episodes are all very real possibilities.

There's an elephant in the room and no one wants to acknowledge it.

My current take is that we could see a Flash Crash of some kind soon, followed by a recovery and then a bigger, more protracted crash, or we could see a more normal decline to the 200 EMA followed by a relief rally and then a major crash.  The conditions are present, but it is not possible to determine exactly when and how those conditions will coalesce into a market event.  My tendency, given the current amazing URSA MAJOR synchronous alignment of markets and forces (beginning on a perigee full moon no less!) is to expect the unexpected this week.  There is a small outlier chance that, like in June 2011, we will see an out-of-the-blue surprise market rally first, but frankly I think that the recent April rally fulfilled that function (rather poorly) and we are already beyond that point in the sequence.

On the whole my expectations are that the sum of the decline will be worse than 2011 but not as bad as 2008. And when the market has vomited up the last share and you can't pay people to own stocks, that will be the time to buy for a new Bull Market.

COPYRIGHT 2012 STEVEN VINCENT, THEBULLBEAR.COM
NO REUSE, REDISTRIBUTION OR CITATION OF ANY KIND IS AUTHORIZED WITHOUT EXPRESS CONSENT

Steven Vincent
Steven@TheBullBear.com