An Inflection Year?
Updated: Apr 14, 2020
After witnessing a dramatic surge to new all-time highs to start of the New Year (2020) U.S. stock market indexes abruptly reversed direction and entered bear market territories in a few weeks. Signs now point to the U.S. stock market headed toward an inflection point this year. So, what is an inflection point? An inflection point refers to a major turning point in the direction of the market trend. In the financial markets there have been a few dramatic turns or inflection points including the 1929-1932 great bear market that led to great depression. In the area of technology, the proliferation of wireless technology and internet lead to the Technology revolution and the 1982-2000 structural bull. Most inflections aren’t so obvious and dramatic. It can take many years to fully develop. So, are there technical signs to warrant an inflection point this year?
Outside days and outside weeks are common and popular patterns that often shows up on individual stocks and major market indexes. Monthly outside months not as popular but still appears on the monthly charts. Outside years are extremely rare as these patterns occurred only handful of times over the past century in major stock market indexes.
An outside pattern is represented by either a bullish engulfing formation (positive outside day, week, month, and year) or a bearish engulfing pattern (negative outside day, week, month, and year). This price pattern indicates the potential for a change in trend. A daily positive or negative outside day signals a near-term trend change. A weekly positive or negative outside week implies a bullish or bearish reversal pattern over the intermediate-term trend. A monthly positive outside month or negative outside month hints of a long-term directional trend change. A yearly positive outside or negative outside year imply a long-term structural trend change.
The confirmation of an outside year depends on the closing price at the end of the year. This rare technical formation does not occur for no reason at all. It is typically the direct result of the convergences of structural forces that influence the very long-trend. Enclosed below are the yearly charts of two key major U.S. market indexes (Dow Jones Industrial Average (INDU) and S&P 500 Index (SPX)) and their respective outside year formations.
Dow Jones Industrial Average (INDU – 22,327.48)
An outside year is a rare but potentially important yearly reversal pattern that may alert astute and experienced investors to a structural trend change. Since 1900s, there have been 7 outside year patterns in INDU. 3 of these were defined as negative outside years (i.e., 1937, 1966, and 1973) and 4 were denoted by positive outside years (i.e., 1949, 1980, 1982, and 2016).
The onsets of these outside year patterns have either led to the end of a structural trend and the start of a new structural trend or have reinforced the dominant and prevailing structural trends. For instance, a positive outside year during 1949 promptly ended the 1929-1949 structural bear trend and the start of the 1949-1965 structural bull trend. The 1980 and 1982 positive outside years occurred during the double dip recession period leading to the capitulation phase to the 1965-1982 structural bear. On three other occurrences, the negative outside year in 1937 ended the 1932-1936 cyclical bull rally leading to the resumption of the 1929-1949 structural bear. The negative outside year in 1966 and again in 1973 prolonged the 1966-1982 structural bear.
An outside year is developing this year (2020). The outcome of this pattern offers clues to the next structural trend for INDU. A positive outside year can lead to the continuation of the May 2013-present structural bull. However, a negative outside year warns of the next structural bear.
On another note, since 1800s, structural trends (both of bull and bear) in the U.S. stock market have spanned from 8-years to 20-years. If a negative outside year is confirmed by the end of the year this will likely mark the end to the May 2013 structural bull. However, this structural bull will be the shortest of all structural trends both bull and bear in U.S. history. It is a strong possibility that INDU may continue to struggle during the first half of the year. But, by the second half of the year INDU begins to rally strongly into the year thereby closing the year at or near the top of its intra-year range. This confirms a positive outside year and signals the resumption of the May 2013 structural bull.
S&P 500 Index (SPX – 2,626.65)
SPX is also nearing a critical phase as evidenced by the onset of an outside year as well as key test of pivotal long-term support zones including the 10-year ma (2,191) and the middle of its very long-term structural trend line (blue dash line - 2,125). The outcome of these tests and the resolution of an outside year pattern may help to decide the next directional trend of SPX for many years and even decades to come.
Three possible outcomes are possible: (1) continuation of the May 2013 structural bull trend, (2) start of a structural bear trend, and (3) continuation of a volatile and sideways trading range market environment.
A convincing violation of 2,125 coupled with a negative outside year warns of a major SPX top and hints of the next structural bear decline toward the 30-year ma (1,393), and below this to 1,150 (red dash line and bottom of its long-term yearly uptrend channel). On the other hand, the ability of SPX to maintain above 2,125-2,191 coupled with a positive outside year can also trigger the resumption of the May 2013 structural bull. Under this scenario SPX trends toward the top of its very long-term uptrend channel at 4,600-plus (green dash line), over time. However, if SPX closes near the middle of its yearly trading range then this is neither a positive outside year nor a negative outside year. Under this technical condition, SPX is likely to continue with its neutral trend via a choppy and volatile trading range market environment.