Monday, December 23, 2013

Divergences vs. momentum and seasonal tendencies

Since early last month, I have been pointing out and discussing several developing negative divergences for the stock market. In that time, the S&P 500 has risen, pulled back and with last week's Fed announcement, shot up to attain a new all-time high -- net net, about a 3% gain. Impressive. 

A defining characteristic of divergences is they can very often emerge and develop for some time before having their effects materialize. Divergences can also eventually disappear as conditions change and whatever disconnect was in place dissipates, taking with it any implication stemming from the divergence.

Currently, some key negative divergences do remain in effect. One in particular is the percentage of NYSE stocks above their 50-day moving average.

Note in the chart above that the percentage of NYSE stocks above their 50-day MA is just shy of 60%. This figure has improved from the recent low of 45%, but remains well below the 70% threshold (blue line) that typically is reached or surpassed when the S&P 500 registers a new high. This indicator could continue to climb and get to 70+%, however for now it continues to qualify as a negative divergence.

I would mention that some of the bearish divergences that were lingering in place for the last few weeks have in fact disappeared. One that I had identified on December 15 as already showing signs of becoming a near-term bullish divergence was the relative performance of cyclical stocks versus staples.

The CYC:XLP ratio achieved a new high early last week when the S&P 500 was still near its pullback lows of approximately 1780. 

In the face of any headwinds associated with persistent bearish divergences are the tailwinds that come with favorable seasonal tendencies coupled with healthy momentum. As I stated last week, we have entered what has historically and consistently been one of the best three-week periods for the stock market. Whether considering a trailing 5-, 10- or 50-year average, mid-December through the first week in January has typically been exceptionally bullish for equities. 

As for momentum, I submit the following S&P 500 chart:

The lower insets show the 5-day (weekly) rate of change (ROC), the 21-day (monthly) rate of change and the stochastic (STO), respectively. Recent momentum in the market has been very robust as evidenced by the 5-day ROC and the STO. Whenever price has accelerated at 2+% over five days and the stochastic has lifted higher in near vertical fashion, it indicates well above-average momentum which provides significant thrust to typically drive stocks higher for days or even weeks to come. And it's also important to note that more intermediate-term momentum as depicted by the 21-day ROC is not already stretched or at an extended level, meaning the near-term rally is not occurring within a longer-term potentially peaking or exhausted advance.

In sum, shorter-term momentum has been very strong and is synchronized with more intermediate-term momentum to suggest further gains should ensue. Also supporting the case for a continued rally is the previously mentioned seasonal tailwind. For the time being, worrisome implications from any bearish divergences will likely take a backseat -- at least until early January.

(Source for all charts:

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