I recently watched the Bloomberg interview with Jeremy Grantham, the well-known investor who has been loudly predicting another 1929 or 2000-style market collapse. Whether you agree or disagree with his prediction, it’s still a great interview, and someone with the stature of Grantham should not be ignored when he issues major warnings about the market.

Here’s the video in full:

Grantham got me thinking about market crashes, specifically how they begin. How long does it take for a market rally to stall out and turn into a crash?

Is it something that we can see coming? Does it happen rather quickly and without much warning? Is there a typical sign we can see in the charts at every prior market top, or at least a lot of them?

I decided I would study the charts of the following market crashes:

  • The S&P 500 in 2007
  • The Nasdaq in 2000
  • The S&P in 1973
  • The Dow in 1929

Those are the only crashes in US history that really fit the bill for what Grantham is predicting: a complete and total implosion.

First, here’s the annotated chart for 2007:

As you can see from the chart dates, the whole topping process took over 8 months. But the chart displayed a clear head and shoulders top, then a final break below the neckline support in early 2008. At that point the market was toast. It tried to rally in April, but other than a brief false break above the previous neckline (old support now acting as new resistance), but the downtrend was sustained. By December the S&P index was at 750, and would eventually bottom out in early March 2009 at an intraday low of 666, as I’m sure a lot of investors remember.

Total decline: 57%.

Next up is the Nasdaq in 2000:

The topping process in 2000 was very fast. It all happened within the span of a month, March, incidentally.

This was not a head-and-shoulders top, it was a double top. The market made a new high, dropped, rallied and then failed to make a new high, which caused another drop, which bounced off the neckline support briefly before dropping below it. The Nasdaq then tried to rally, and temporarily got back over the neckline support (again, previous support now becomes resistance) but immediately got slammed down that took the Nasdaq down over 1000 points. It was game over for the tech bubble at that point.

We can also see RSI deteriorating significantly going back to early January 2000 even though market prices were increasing. When you see deteriorating RSi but ascending prices, that’s a sign that a drop in prices is coming. That’s a bearish RSI divergence, and we also saw it in 2007, although not as dramatically.

So the whole topping process only took a month, maybe even a little less.

Total decline in Nasdaq: 78%.

Here’s 1973, which I’ll do in two chart:

You can see the head and shoulders top, you can see the bearish divergence in RSI, and you can see the downward channel.

But zooming out on the chart gives us a better picture:

This bear market took a long-ass time to top out, over two years. You can see the true neckline support level dates back to late 1971 and isn’t finally broken until late summer 1974. What we had here was a resistance level around 112, then the false breakout to new highs at about 120 in late 1972/early 1973, followed by the downward channel. Stocks then tried to rally back in the fall of 1973, but the old resistance at 112 proved to be a ceiling for stock prices. That led to a sharp decline, then a bounce off of the true neckline support at about the 90 level. The market tried to stay above that support, but eventually deteriorated, and once it broke below 90, that was all she wrote. The market went into complete freefall in July and didn’t reach a final bottom until October 7.

So this bear market had the head-and-shoulders top, it had deteriorating RSI (again, when markets make new highs but RSI doesn’t), but the topping process was long and drawn-out.

Total decline: 49%.

Now we go to the greatest crash of them all: 1929:

This is just the beginning of that crash. It continued all the way into June 1932. But I want to just focus on the topping-out process.

We see the head-and-shoulders top, which took about 4 months (July-October). We see a breakdown below the neckline support, but then a brief false-breakout rally above it, which was short-lived, and then the final break below the neckline in mid-October sealed the deal.

Like the crash of 2000, this one topped-out quickly. As soon as the market failed to make a fresh new high in October, the crash was on. In early September, the market was at the high of 381, and within two months it was down 50%.


Okay, so what does that mean for us today?

Here’s the Nasdaq chart as of Friday:

We have the head and shoulders top. We have deteriorating RSI.

We broke below the neckline, and despite Friday’s furious rally off the lows, we couldn’t get above the neckline. If we cannot get and stay above the neckline this week, that is not good for the future of this market. I could see a move down to 11900 if the neckline turns out to be a ceiling for the market. But who knows if that level will even hold.

It’s worth noting that we’ve seen other potential head and shoulders patterns during the course of this bull run since 2009, notably in early 2018:

However, in that situation we never broke below the neckline after the right shoulder; in fact the markets never even tested the neckline support. So that selloff was never anywhere near as dangerous as it is today.

Similar pattern observed in early 2014:

You see the neckline support, you see the head-and-shoulders pattern, but again we never retested the neckline support after the right shoulder rolled over.

There are a few other examples of possible head-and-shoulders tops from this bull market. There was one in late 2015, but did not come at all-time highs. Then there was one in early 2010, but that was barely a year after the 2009 bottom.

We still have to wait and see whether or not this is going to turn into a major crash or recover. The market would have to rally about 11% from current levels in order to make a new high, and that might be a tall order.

Since it’s Sunday night, futures have already opened. They opened slightly higher, but Nasdaq futures are now sitting at 12568, well below the high of 12761. That’s a drop of about 1.5%. We could be in for a very red Monday.

This week is critical.

Leave a Reply