Investor Alert
Simon Maierhofer

Nov. 30, 2016, 1:05 p.m. EST

Don't be fooled by this uber-bearish Dow formation

By Simon Maierhofer

Getty Images

Back in July, 30-year Treasury bonds carved out a bearish formation labeled ending diagonal (see below). The iShares 20+ Year Treasury Bond ETF (NAS:TLT)  dropped as much as 16.9% thereafter. Right now, the Dow Jones Industrial Average (DOW:DJIA)  is in the late-stage development of the same pattern. Will the DJIA suffer the same consequences? Although some patterns look the same, not all patterns are created equal.

Despite the immense bearish energy associated with every ending diagonal, free markets don't allow themselves to be squeezed into a “one fits all” approach. To assess the DJIA downside risk, it's necessary to look beyond the pattern.

Cookie-cutter analysis trap

The chart below reflects a “perfect world” diagonal according to Elliott Wave Theory (EWT). I've seen some horrid EWT interpretation, so I understand anyone why dismisses EWT as hocus-pocus.

But there is merit to EWT at certain times, as this very recent real-life S&P 500 pattern powerfully illustrates.

The 30-year Treasury chart right next to the idealized ending diagonal pattern below was published in the July 7 Profit Radar Report with the following comment:

" 10-year bond yields are at all-time lows, and 30-year Treasury prices are at all time highs. Commercial hedgers have racked up the highest short exposure since 1998, while the 'dumb money' is piling into the crowded traded.

Sentiment truly is worthy of a sizeable reversal. Down side risk is much greater than up side potential ."

Back in July, investors were as bullish as can be on Treasurys, and the multi-decade Treasurys bull market had to come to an end at some point. Investor sentiment confirmed the bearish implications of the ending diagonal.

DJIA ending diagonal decoy?

The chart below shows the potential DJIA ending diagonal. Purely from a charting point of view, it looks valid.

However, investor sentiment is not nearly as bullish for stocks now as it was for bonds a few months ago. Stock market seasonality is bullish, and liquidity is more bullish than bearish.

The trend line forming diagonal resistance may cause a pullback (watch 18,800 or 18,600), but there is not the same bearish potential as for Treasury bonds in July.

In fact, upon completion of any pullback, based on one unique indicator (that's actually confirmed by others), the stock market's up side potential is quite enormous. Why and how much upside is discussed here .

Link to MarketWatch's Slice.