A Simple Twist of Fate?

by Brian Pretti CFA, Contrary Investor. November 9, 2007

I don't know about you, but I'm pretty sick and tired of watching the "we're x points away from an all time new high" screens flashing on the financial market infomercial channel over the recent past. Luckily I'm not subjected to the verbal commentary onslaught as I only tune in sparingly and only under one condition - the sound must be turned off. Funny, at least in terms of the S&P, these screens have not read "we're only x points away from getting your money back after almost eight years!" But that is the reality akin to the approaching new highs banter, at least for the broad S&P 500. Anyway, I do want to talk about a potentially very important new high that seems to be given little to no attention anywhere I look. And it just so happens that after the Fed rate cut last week, we were quite close to the happy occasion. Getting right to the point, I'm talking about a potential inflation adjusted new high on the Dow. I believe the charts below deserve some attention and thought. We're either looking at the confluence of perhaps some important and coincidental double tops of the moment, or it’s just a simple twist of fate.

In the first graph directly below I'm going back to the monthly high in the Dow in December of 1999 and then inflation adjusting the Dow using the CPI from then moving forward. As of the close on October 31, we were within a few hundred points of that prior high using this inflation adjustment. So, on an inflation-adjusted basis, as of the beginning of this month we were on the cusp of achieving a very large and long-term double top in the Dow. One that seems absolutely hidden from view in terms of the mainstream. Hidden from view while in plain sight for those who can "see." Of course the dotted line in the chart below is the nominal price of the Dow for contrast set against the inflation-adjusted series alongside. Personally, I believe this is a double top not to be lightly dismissed. Certainly, I do not mean to turn this into some wild major equity market top call right here, as no one can do that with any type of consistent accuracy, but what intrigues me in terms of timing is that this potential double top in the inflation adjusted Dow is occurring at the exact time that we again recently approached a nominal dollar double top in another major US equity average – the S&P. Pure coincidence? Maybe so. But interesting nonetheless in terms of the simultaneity of occurrence. (So you have a frame of reference, and just to be a nice guy, I marked the Dow in the chart below at 13,950.)

While I'm on the subject, two more quick charts of interest. What the heck, why not have a look at the S&P on an inflation-adjusted basis over this same period? It's what you see directly below. Hopefully without stretching for relationships, the retracement of the inflation adjusted S&P 500 (priced at a nominal 1550 in the chart) from its 2000-2002 drop bear market range is very close to a 61.8% Fibonacci retracement level. Very close. A meaningful demarcation line for the technicians of this world. A simple twist of fate? Or a market that is showing us a number of simultaneous double tops?

Final chart simply for historical perspective. For those of you old enough to remember, the wonderful US equity market put in a very meaningful peak really in the late 1960's. Although that important top was broached to the upside on a nominal basis in the early 1970's, it was never bested on an inflation-adjusted basis for literally decades. Here's the visual.

Could it be that perhaps the S&P is repeating this performance, or character rhythm? The answer lies in our future.

Who knows, maybe this is all mindless speculation. Maybe I'm looking too hard for dark clouds behind every silver lining. Or perhaps a meaningful, as of now, double top of significance for the Dow is simply hidden while in plain view. Hidden while the CNBC carnival barkers sing of new highs. Hidden at the exact time the S&P has put in a near eight year nominal price double top, and rests quite near the 61.8% Fibonacci retracement level of its entire early decade bear market on the inflation adjusted basis. Remember, double tops can be quite the powerful technical demarcation line. Failure at double tops is a message not to be summarily overlooked.

Before signing off, one last chart I've been watching while the S&P and Dow struggle with their respective double top formations described. It's a chart of cumulative NYSE breadth. As I'm sure you are aware, one very noticeable characteristic of the equity recovery rally off of the August lows in recent months has been lack of breadth. In fact, this is one of the first recovery rallies dating all the way back to early 2003 where cumulative breadth has not gone on to make a new high while the major headline equity averages bested their summer time highs on a nominal price basis. It's a divergence. As you look at the following chart, also please notice that since early 2003, the 200-day moving average of NYSE cumulative breadth line has acted as very important downside support, only broken in a less than minor manner both in August of this year and now. If indeed breadth does not improve and cumulative NYSE breadth holds below the 200 day MA sustained, it would absolutely heighten my trepidation that the simultaneous double tops in the Dow and S&P I described above are indeed quite the important markers demanding of our attention as investors.

Brian Pretti

Contact Information

Brian Pretti CFA | Editor and Publisher, Contrary Investor
P. O. Box 4402 | Walnut Creek, CA 94596 | Observations | E-mail