Published: May 1, 2019 4:36 p.m. ET

A bullish inverse head-and-shoulders pattern is cropping up

MarketWatch photo illustration/FactSet, Getty Images

Author photo By MarkDeCambre

A bullish chart pattern, known as an inverse head and shoulders, is cropping up in a number of assets and indexes in recent trade and suggests that the broader equity market may have more room to run beyond its current record levels, according to Asbury Research.

The typical head-and shoulders pattern is formed when three successive peaks are reached in a charted security. Those peaks are described as the left shoulder and right shoulder, the head representing the highest peak in the middle, and a neckline linking two low points.

An inverted head-and-shoulders, however, is the mirror image of this traditional formation, and points to a rising rather than a bearish, or reversing trend.

The pattern has emerged in small-capitalization stocks, notably the Russell 2000 index RUT, -0.93% :

The small-cap benchmark had led the charge in the wake of a collapse in the market in late 2018, which culminated in a vicious selloff on Dec. 24, which dragged the S&P 500 index SPX, -0.75% the Dow Jones Industrial Average DJIA, -0.61% and the Nasdaq Composite Index COMP, -0.57%  to their worst monthly losses since the 2008 financial crisis.

However, gains for the Russell have cooled somewhat, rising 5.9% over the past three months, compared with an 8.8% rally for the S&P 500, and a nearly 12% advance over the past 90 days in the Nasdaq, according to FactSet data.

A inverse head-and-shoulders pattern also is forming in the Dow Jones Transportation Average DJT, -1.71%

Funds that mimic the closely watched index, including the SPDR S&P Transportation ETF XTN, -1.61%  and the more widely traded iShares Transportation Average ETF also show the inverse formation (see chart of the SPDR’s transportation exchange-traded fund):

…and the same holds true for the financial sector, per the Financial Select Sector SPDR ETF XLF, -0.25% :

…it can be found even outside the U.S., in the form of the country-specific iShares MSCI Japan ETF EWJ, -0.13% :

Asbury Research’s Chief Market Strategist John Kosar told MarketWatch that in isolation a head-and-shoulders pattern forming isn’t as significant as the chart formation occurring in a number of different assets.

Kosar said: “I like to see something behind the head and shoulders…what I look for is ‘do I see the pattern everywhere else?’ All of these markets and indexes generally move together, so if you are looking at a large market pattern it is usually corroborated elsewhere,” he said.

Gains for some of those sectors may has help boost the broader market since it would represent added participation in the recent rally for equity markets off the late December nadir.

To be sure, Kosar said the head-and-shoulders pattern is only one indicator that he uses to establish trends in the market, and cautions investors against putting too much weight in any one signal or chart pattern.

“It doesn’t mean that you can put everything on black, these patterns can still break down,” he said.

Any expectations for a further run-up in an already powerful rally in major benchmarks must factor recent year-to-date advances for the S&P 500, up 17.5% thus far, representing its best start to a year since 1987, while the Dow, up 14.1%, has produced its best first four months to a calendar year since 1999, according to Dow Jones Market Data.

The market’s steady climb combined with the fact that the economic cycle, in its 10th year of expansion, is considered long in the tooth and likely to slow in the coming months, if not years, should encourage Wall Street investors to invest prudently.

More detailed charts and analysis of the topics discussed by John Kosar in this article can be found in our premium reports.  Subscribers can log into the Research Center to view them.

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