Do the Jaws of Death predict a bear market?
At this time both the Dow Jones Index and the S&P500 are showing a significant reversal pattern which has preceded most of the great bear markets over the last 100 years. The pattern is variously called the jaws of death, a broadening top pattern or a megaphone. The pattern is shown on the monthly chart of the Dow Jones below. This expanding pattern typically shows the waves a, b, c, d, e, with the downward sloping boundary given by the lows of waves b and d and the upper boundary provided by the tops of waves a, c and e. In all examples of this pattern, wave e is by far the longest but wave e is variable and may terminate at the upper trend line or move much higher before reversing.
This pattern appeared immediately prior to the crashes of 2007, 2000 and 1987 as well as the crashes of 1973, 1957 and 1929. While the present pattern may not presage another crash, in view of its apparent association with past crashes it is worth examining in more detail.
In past bear markets this pattern has developed over a number of months. This present pattern is different in that it has developed over some 15 years. It is well established that patterns over the longer time frames are more significant than short term patterns so the very long term nature of this present Jaws of Death pattern means that it should not be ignored.
But must this pattern presage a bear market? Since this pattern is at the top of a trend, an upward breakout is a continuation and a downward breakout means a reversal. Bulkowski in his highly regarded book “Encyclopedia of Chart Patterns” notes after analyzing many occurrences of this pattern, that the number of breakouts or reversals is split almost evenly between a reversal of the prevailing price trend and a continuation. This is in contrast to the view of most technical analysts that this is only to be regarded as a strongly bearish reversal pattern.
As for volume with this pattern, Bulkowski says that usually “the volume mimics the price pattern so that it will be rising and falling along with price”. It is interesting that with this current example the pattern of volume on the monthly DOW chart is quite different. After the March 2009 low, there is a significant continuing decline in volume while price makes rapid gains as illustrated in the chart below. This may indeed be significant.
Despite the overall impression among technical analysts that this Jaws of Death pattern can only be very bearish, given the analysis by Bulkowski an entirely bearish scenario is not assured. While in the past this pattern has been a frequent prelude to significant bear markets there are a number of examples where this pattern provides a continuation and not a reversal leading to a bear market.
In this present situation, which applies to both the Dow and the S&P500, the significant continuing decline in volume over the longer term development of this pattern is a concern, as is the magnitude of the very long term nature of its development and this should be of concern.
What are we to conclude from these current Jaws of Death pattern? Are we about to witness the beginning of a very significant bear market or will there just be a correction which will offer an opportunity to buy into the next significant bull market? Given the interesting stage of world fundamentals, I rather suspect the latter.
As an aside
It is of interest to note that Elliot Wave proponents believe that equities are making a final rally to a major top which in their view will be the beginning a Grand Super cycle degree bear market. They contend that this will be a very significant bear market which will be greater than the bear market of 2007 to 2009, and rival the great depression bear market of the 1930′s.