By Jim Donnelly, Olson Global Markets

It is no secret that a bearish Head & Shoulders pattern on the S&P 500 Index appears to have formed on daily bar charts. A good deal of attention has been paid to the development of this formation earlier last week by a number of broadcast business sources. Bearish technical divergences, a loss of bullish momentum and a decline in trading volume have accompanied this set-up, as it should be.

Interestingly, the target or “objective” of this near-term pattern suggests that a pullback to the 818 level is now likely. This is an interesting observation since the targeted level of the bearish Head & Shoulders pattern coincides roughly with an expected correction that may well result in the formation of the “right shoulder” of a larger, more important bullish reverse Head & Shoulders pattern on weekly charts. Another thing worthy of note is that this larger bullish pattern is remarkably similar is size and scope of one that developed between 2002 and 2003 following the shock of 9/11.

If is assessment is accurate, volume levels should begin to increase considerably as the 818 area is approached. Volatility levels should also rise briskly as the distribution of shares takes place. If these technical features along with basing price activity are present when the pullback occurs, there would be a good case to be made for a brighter second half on 2009 regarding the S&P 500 Index.

Failure of a reversal of this kind to develop, however, would become a worry which could bolster a more bearish scenario for stocks in the quarters ahead.

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