For two months, we have been monitoring developing weakness in the historic stock market bubble that has suggested the bull market from 2009 is becoming susceptible to a long-term reversal. The short-term breakdown in early June was followed by a quick move down to long-term support at the 200-day moving average in late June. That critical support level was tested in early July before a violent rebound returned the S&P 500 index to recent highs of the cyclical bull market. However, last week, prices reversed again and moved sharply lower, approaching the 200-day moving average for a second time.
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The 200-day moving average is important long-term support and a confirmed break below that level would be a major bearish development, signaling the likely start of a substantial correction. While the S&P 500 index remains above that key level for the moment, the Dow Jones Industrial Average closed well below its 200-day moving average on Friday. A subsequent close below congestion support in the 17,500 area would confirm the breakdown and forecast substantial losses.
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The Dow Jones Transportation Average broke below its 200-day moving average in April and this index has been trending lower since March.
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When stock market indices negatively diverge in this manner, the behavior is yet another warning sign that a long-term reversal may be in progress. In isolation, this type of divergence is not a significant warning sign, but when combined with historic market risk and deteriorating market internals, this price behavior is a meaningful development. As we often note, a cyclical top is a process, not an event, so it will be important to monitor market behavior closely during the next several weeks. If the S&P 500 index joins the Dow Jones Industrial and Transportation Averages in breaking below its 200-day moving average, the likelihood of a long-term reversal will increase substantially.