Wednesday, July 31, 2013

Market update: Patience is needed

Since the market bottomed on June 24th, the smaller the cap size, the greater the gain.

It's generally a bullish sign when smaller-cap stocks are outperforming their larger brethren, inferring "risk-on"-type investor behavior. 

However, the market has stalled out over the last five days and during this time smaller-caps have reversed course and underperformed:

Understandably, five days do not make a trend but it's certainly something to keep tabs on. 

On July 17th, when the S&P 500 was at 1675, I wrote that I "expect[ed] another run at new highs," in part due to the "good overbought" condition observed in the hourly chart. The Index did shoot higher, getting very close to 1700 before pulling back to its current 1685 level. 

But much of the extreme "good overbought" hourly momentum has been worked off and the daily chart is exhibiting declining momentum via the stochastic along with an imminent MACD sell signal.

I am also growing concerned about a few bearish divergences starting to develop, such as the percentage of NYSE stocks above their 200-day moving average.

As I show with red lines in the chart, this breadth indicator (lower inset) can very often give timely warnings before key market turning points (S&P 500, upper inset). Currently the percentage of NYSE stocks above their 200-day MA is 70%, which is well below its prior high of 80+% in May. Meanwhile, the stock market is higher since that time, creating a bearish divergence.

Other indicators I follow are not yet flashing negative signs, remaining either bullish or neutral, so I'm concerned but not alarmed. As I've mentioned in prior posts, the YTD rally has been characterized by very strong momentum, translating into very forceful thrust. Under such circumstances, the market does not typically die quickly or collapse overnight, but rather any weakness is often followed by rallies, creating a more protracted and volatile topping phase. That of course assumes we are in fact topping, which I would argue is too early to tell, but the larger point is given the degree of built-up momentum in this extended move, patience is afforded and prudent at this juncture. There's no need to panic. 

As always, I'll keep a close eye on my many indicators and report back if anything were to change. Stay tuned.
(The source for all charts above:

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