Signal Type	Trade Date	Index	Return since issued
		Nasdaq 100
		Russell 2000
		S&P 500

Market Update

Stocks continued to lose ground this week. Even though the major indexes were able to close well off their lows Monday and appeared to find stability the next day, they plunged again towards the end of Tuesday's session after AT&T reignited recession fears by warning of weakness in its consumer business. The Nasdaq Composite lost 2.4% Tuesday, closing lower for the 8^th consecutive day. With such heavy selling leaving the markets oversold, a bounce was to be expected and indeed occurred on Wednesday. Stocks initially opened lower but were able to reverse course to finish in positive territory on increased volume. The day's heavy trade can in part be attributed to short-covering as it is likely that some of the same investors that were shorting in the morning bought back in the afternoon. Despite a weak retail sales report, the market closed modestly higher Thursday after Fed Chairman Ben Bernanke hinted at more interest rate cuts to come and struggling mortgage lender Countrywide Financial was reported to be in buyout talks with Bank of America. Selling resumed in earnest Friday amid renewed fears that the financial sector's woes are far from over and may have severely impacted the earnings of the nation's biggest financial institutions. We will know soon enough as Merrill Lynch, Citigroup and JP Morgan are all due to report their earnings next week.

The Nasdaq 100 , Russell 2000 and S&P 500 posted respective losses of 2.58%, 2.35% and 0.75% on the week. All three indexes remain located below their 200-day Exponential Moving Average (EMA). From a technical standpoint, it should be noted that a significant event occurred Tuesday: the S&P 500's mid-term 50-day EMA closed below the long-term 200-day EMA for the first time since May 2003, possibly signaling that the long uptrend we have experienced since then is over and that a new bear phase has started. Only time will tell, but the current environment is certainly one where extra caution should be exercised.

Our World Index Ranking portfolio again outperformed its US counterparts this week with a loss of only 0.24%. The portfolio consists of the 5 top-ranked world indexes as of January 4, which marked the beginning of the current 4-week holding period. Please note that since we now have an active Sell signal, the World Index Ranking approach calls for selling your holdings if you follow the "Long Only" or "Long and Short" strategy. Only if you follow the "Buy and Rebalance" strategy should you remain invested in the top 5 indexes, as the strategy calls for staying invested at all times. Please go to our "Strategies" page for all the details.

Our current Sell signal remains in effect.

Trend Timing School

Head-and-shoulders reversal

Our Trend Timing School topics are for the most part not about current events. That's what the Market Updates deal with. But sometimes the timing is just right for the perfect learning opportunity as history is being made in front of our eyes. The legions of astute technical analysts out there have not failed to notice that U.S. markets have been topping for months and now have just about completed the most recognized of all charting patterns: an almost textbook perfect head-and-shoulders reversal.

As Edwards and Magee had already figured out in their famous book "Technical Analysis of Stock Trends, 8th Edition" back in 1948, the head-and-shoulders top formation is one of the most common and most reliable of the major reversal patterns.

Here's the anatomy of a typical head-and-shoulders reversal pattern for which the 2000 market top in Chart 1 provides a perfect illustration:

The 4 elements listed above are required for the top formation to be confirmed, but real life head-and-shoulders trend reversals come in many shapes and durations. There are frequently numerous shorter and longer term necklines one could draw depending on the period of observation. There are often multiple left and right shoulders, and double top heads. Sometimes, reverse head-and-shoulders are also used to spot market bottoms.

Chart 1: Classic head-and-shoulders: the 2000 market top



Getting back to the present situation we examine Chart 2 below which shows the head-and-shoulders formation of the S&P 500 index which has been forming a left shoulder in July of 2007, a head in October and the right shoulder in December. Right on cue we have now broken the neckline, albeit not yet decisively. Frequently, the neckline break is followed by a loss of downside momentum and volume as well as short pullbacks to challenge the neckline, which now acts as resistance zone, before turning down for good.

Chart 2: Neckline broken on current head-and-shoulders formation



An interesting twist to the head-and-shoulders reversal theory is to use the charts to predict the magnitude of the ensuing drop. Measure the vertical distance between the top of the head and the neckline, then measure that same distance down from where it was broken to the downside. This puts the current S&P 500 price objective at about 1250 which would be a drop of more than 20% from its October top.

Charts such as the head-and-shoulder pattern play no role in our Model. Nevertheless, we always welcome technical indicators that abound in the direction of the current trend as affirmation, reinforcement and validation of our position. We don't know if this head-and-shoulders formation will lead to the more significant drop analysts anticipate but, if nothing else, it makes us feel better.

For those of you who had gotten a little skittish about our signals and have been hesitant to pull the sell trigger (once burned, twice shy), or anyone just in need of confirmation, this classic charting top formation seldom fails to accurately declare a trend reversal and you would be well advised to heed the call.

FAQ of the Week

Question: Are we in a bear market yet?

It is amazing what 8 consecutive down days on the Nasdaq Composite index can do to investor psychology. Many start wondering if this already qualifies as a bear market.

There are numerous bear market definitions investors use and the various indexes reach bear market status at different times. One definition we have used for a long time (see "The psychology of bull and bear markets") is a simple technical analysis method combining 10-day and 200-day exponential moving averages (EMA). Whenever the faster moving EMA (10) is above EMA (200) we are in a predominant bull market, otherwise we are in a bear market. These two lines have been crossing each other since mid-December and now have a bear reading. Another popular measure uses the 50-day and the 200-day averages as plotted for the S&P 500 index in Chart 3 below. The crossover of this indicator just occurred this week signaling the start of a bear market.

Chart 3: Downside crossover of 50- and 200-day exponential moving averages



The only major bear market definition which has not been reached yet is a decline of 20% or more from an intermediate top (10% to 20% declines are called corrections). If the head-and-shoulders pattern discussed in the Trend Timing School article above delivers on its price objective for the S&P 500, we will solidly be in bear market territory by all measures.

Warm wishes and until next week.

The TimingCube Staff