U.S. stocks could sink by more than 20 percent if the neckline of a head-and-shoulders pattern on the Dow Jones Industrial Average is breached, according to Robert Prechter’s Elliott Wave International Inc.
“The coming months hold the potential to be the most exciting of the year so far,” a team including Steve Hochberg and Peter Kendall wrote in their latest Global Market Perspective report. “Once the neckline is breached, the measured move for the selloff targets the area surrounding 8,000.”
A head-and-shoulders pattern occurs when an index forms three consecutive peaks, with the middle being the highest. The start of a decline is signaled when prices fall below a support level in line with the low points between the peaks. The Dow average traced the left shoulder of the pattern in January, followed by the head in April, according to the report.
The right shoulder of the pattern is now ending and the downward-sloping neckline “displays market weakness,” the report said. The Dow, which declined 0.5 percent to 10,355.14 at 10:35 a.m. in New York, has fallen 7.5 percent from this year’s highest closing level on April 26 amid concern that European nations will struggle to reduce their budget deficits and speculation that the U.S. economic recovery may be flagging.
‘Several Thousand Points’
“The message from Elliott waves as well as this particular technical pattern, on both a long- and intermediate-term basis, is that the Dow’s next significant move should be a decline of several thousand points,” the report said. “The next phase of selling should be broad-based, with all sectors participating.”
Prechter is famed for predicting the stock market crash of 1987 via a system of measuring investor psychology known as the Elliott Wave Principle, though his forecasts have had mixed results. His standing suffered in the 1990s when he missed the almost decade-long bull market. In December 2002, he said the Dow would fall below 1,000. It hasn’t dipped below 6,000 since then, climbing 25 percent in 2003 and another 35 percent through Oct. 9, 2007.
The Elliott Wave Theory was originally developed by accountant Ralph Nelson Elliott during the Great Depression. Elliott concluded that market swings, or waves, follow a predictable, five-stage structure of three steps forward, two steps back.
Technical analysts observe price charts to forecast resistance levels, or ceilings restricting further price increases, and support levels, or floors limiting declines. The trading patterns and prices are used to predict changes in a security, commodity, currency or index.