Triple Top Panic Time for the S&P? Not Yet.

by Daniel Putnam | April 24, 2013 8:23 am

The S&P 500 Index has been bouncing back and forth in the 1540-1600 range for four weeks since it first hit a record high, and this lack of upside momentum is beginning to fuel talk of a “triple top” in the index. But even with the S&P sitting near the same level from which it crashed in each of the last two market downturns, this technical picture isn’t necessarily a cause for concern.

First, the S&P is the only major, broad-based index that hasn’t surged well above its previous high. The Dow Jones Industrial Average, S&P MidCap 400 and Russell 2000 indices have all surpassed their old highs by a wide margin, and they have left the S&P in the dust in the past 12 months:

Index One-Year Return
Dow Jones Industrial Average 15.6%
S&P 500 Index 14.3%
S&P MidCap 400 Index 16.5%
Russell 2000 Index 15.5%

The most important factor in the S&P 500’s underperformance vs. the other three indices is the downturn in Apple (NASDAQ:AAPL[1]). The stock has collapsed 42.6% since its Sept. 19 high, which has shaved more than 2 percentage points from the S&P 500’s return while leaving the other three indices unscathed. In this sense, the triple top is as much a result of index composition factors as it is a signal of broader market health.

The second reason why the triple top isn’t necessarily a negative is that the current chart position, by itself, doesn’t imply that a downturn is the next step. In fact, the S&P 500 could well follow the other indices by breaking out to further new highs.

The precedent for this sort of multi-year triple-top is fairly limited, but there are two instances in which this has occurred — both in the Dow Jones Industrial Average. And as the charts below demonstrate, neither setup ended well.

From 1905 to 1913, the Dow made three moves into the 94-103 range — each with a lower high — before finally collapsing 43.5% in the following four years.

dow1 1024x768 Triple Top Panic Time for the S&P? Not Yet.[2]

1900-1920

The Dow formed a similar pattern in 1965 to 1973, with a strong breakout occurring before the index finally ran out of steam and cratered 45% in the 1974 bear market.

dow2 Triple Top Panic Time for the S&P? Not Yet.[3]

1960-1980

Of course, neither period featured the kind of central bank support that we’re seeing right now.  

What to Watch For

When is it time to worry? For the financial media, that time could come fairly soon. At this point, a downturn of any magnitude will unleash a flood of experts screaming that the triple top is in. But, as is usually the case, there’s more to the story than that.

The true confirmation that a severe downturn is ahead will occur if the S&P breaks its lower trendline, currently at 1325.

spxlong 300x133 Triple Top Panic Time for the S&P? Not Yet.
Click to Enlarge
As the charts below demonstrate, this was the signal to get out of the market in both 2000 and 2007. That certainly leaves plenty of downside from here — 16%, to be exact — so investors who watch for this still could take a big hit before the real sell signal starts flashing.

spx2013 300x129 Triple Top Panic Time for the S&P? Not Yet.
Click to Enlarge
Still, this trendline can help investors differentiate from a garden-variety selloff — where it might pay to buy the dip — vs. one that requires more meaningful defensive action.

In the meantime, take care not to put too much stock in the flood of “triple top” reports that are sure to accompany the next 2% downturn in the market.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Endnotes:
  1. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  2. [Image]: http://investorplace.com/wp-content/uploads/2013/04/dow1.jpg
  3. [Image]: http://investorplace.com/wp-content/uploads/2013/04/dow2.jpg

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