As I worked through this past weekend’s newsletter, I noticed that multiple markets are starting to exhibit topping patterns. It will be crucial for markets to reverse these patterns in the short-term if the bullish advance continues.

As we discussed yesterday:

“The good news is that the S&P 500 held its 50-dma during its recent selloff. With the market getting back to more oversold levels, we are likely to see a counter-trend rally for a few days that could get us back above the 20-dma. It will be necessary for the rally to set new highs to negate the “head and shoulders” pattern. If the market rallies, fails, and breaks the neckline, we could well see a deeper correction ensue.”

There is an important caveat to this analysis.

The start of “head and shoulder” patterns occurs with quite some regularity during an advancing market. However, they are quite often not completed as the market moves to new highs negating the pattern. Therefore, while we are pointing this pattern out, we are not saying the market is about to go lower. Such will only be if the pattern completes with a break of the “neckline” support.

However, it is important not to dismiss this pattern entirely as it often preceded more substantial declines, as we saw in March of 2020.

Notably, we see this pattern elsewhere.

Same Pattern Popping up Everywhere

Nasdaq Index

The “head and shoulder” pattern is defined better in the Nasdaq. Currently, the neckline support needs to hold, or we will see a more significant correction in the technology sector. With the index more oversold than the S&P 500, I suspect we will see a rally shortly in these stocks, which we will use as a “selling” opportunity to reduce exposure.

Emerging Markets

Like the Nasdaq, we see a very well-defined “head and shoulders” pattern developing here as well. Emerging Markets are very oversold at current levels, so a counter-trend bounce is likely. A failure at the 20-dma is an excellent point to reduce exposure to these cyclical sensitive areas. If economic growth weakens in the U.S., we could see a much deeper correction in Emerging Markets. Watch for a break of the neckline as a “stop-loss” for now.

International Markets

Industrialized International Markets look much the same as the S&P 500. Watch the rising neckline as a trailing “stop-loss.” A failed rally should get used as an opportunity to reduce risk to international markets. Both international and emerging markets are well ahead of any expected growth in the U.S. economy, so the risk of disappointment is high.