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Head and Shoulders Tops

Stocks resumed their declines as investors fear the recent inflation reading will lead to another aggressive rate hike by the Federal Reserve after the FOMC meeting next week.


Expectations the Fed will continue with further rate hikes sent the 10-year U.S. Treasury yields to 3.458%, or close to the high of the year at 3.483%, established in mid-June.


Trading in interest-rate futures is pricing in a 74% chance the Fed will raise rates by 75 basis points at its next meeting and a 26% chance the Fed will raise its target rate by 100 basis points.


Stocks temporarily stabilized on Wednesday after selling off sharply the day before, soon after the Labor Department released inflation data showing CPI remaining stubbornly high during August. The data spooked many investors who expected inflationary pressures to ease, enabling the central bank to slow the pace of its rate hikes.


Stocks witnessed one of the worst trading days since 2020. The market will likely experience heightened volatility into the Fed meeting next week and possibly extending into the end of the quarter window dressing the following week.


The three major indexes experienced erratic trading today. The S&P 500 Index declined 44.66 points or 1.13%, The Dow Jones Industrial Average lost 173.27 points or 0.56%, and the Nasdaq Composite dropped 167.32 points or 1.43%.


Investors may be bracing for another 75-basis point increase next week. However, the stock market suggests few buyers and many more sellers as distribution patterns have developed in stock market indexes.


The daily charts show potential head and shoulders tops in popular stock market indexes such as SPX, INDU, and COMPQ. Although the 4-month bearish patterns have not fully developed and will need several more weeks to a couple of months to complete, the neckline breakdowns, if confirmed, warn of substantial downside risks for stocks.


The height of the distribution tops would imply broad market declines of more than 19-31% from today's closing prices, exceeding the downside projections of many Wall Street strategists and market pundits.


SPX = Breakdown below neckline at 3,636.87 suggests –688.41 points or downside of 2,948.46 or -24.42%. To negate the head/shoulders top, SPX must first surpass its left/right shoulders at 4,119.28-4,177.51 and the head at 4,325.28.


INDU = Breakdown below neckline at 29,653.29 suggests –4,628.07 points or downside of 25,025.22 or -19.17%. To negate the head/shoulders top, INDU must first surpass its left/right shoulders at 32,504.04-33,272.34 and the head at 34,281.36.


COMPQ = Breakdown below neckline at 10,565.13 suggests –2,615.96 points or downside of 7,9409.17 or -31.19%. To negate the head/shoulders top, COMPQ must first surpass its left/right shoulders at 12,270.19-12,320.12 and the head at 13,181.09.


Source: Chart courtesy of StockCharts.com

Source: Chart courtesy of StockCharts.com

Source: Chart courtesy of StockCharts.com

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