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S&P 500: Divergences at Current Levels Warrants Caution

S&P 500: Divergences at Current Levels Warrants Caution

Paul Robinson, Strategist

What’s inside:

  • Up-move now faces significant supply
  • Divergences among major indices is troublesome
  • Fewer stocks participating with the same strength as before

On Monday, when we last discussed the S&P 500 it was set up to reach higher ground based on its short-term technical posturing in addition to a positive sentiment backdrop (repeated dip-trips by buyers during morning sell-offs on not-so-good news.)

But the problem we have been facing from the long-side ever since the bull-flag breakout on May 24, is that while the trend has been higher there lies a lot of supply between here and the old record highs at 2137. This has created choppy trading conditions, and will likely continue to be the case even if the market is poised to achieve new record highs; something which we aren’t convinced of just yet.

Divergence among the indices is troublesome. The S&P 500 notched new 2016 highs while the Dow and Nasdaq 100 have failed to do so. The Nasdaq Composite has stalled at its 2016 highs. To be fair, though, we should note that the higher-beta Russell 2000 small-cap index has been a leader on the latest move higher, which demonstrates some willingness by market participants to snatch up riskier names. But broadly speaking, we are seeing divergence indicative of waning market health.

(We won’t go into this right now, but pulling back even further and comparing the indices from 2015 until now, an even larger set of divergences is unfolding.)

Taking a closer look at the S&P, we are seeing divergence take shape within the components of the index itself. The percentage of stocks trading above the 50-day moving average took a hard dip from overbought levels during the April to May pullback, but has since failed to move back close to those levels despite new highs in the index. Looking at the short-term version of this indicator, we can see the percentage of stocks greater than the 10-day moving average has been rolling over for more than a week despite the S&P consolidating and breaking out to new highs.

(The ‘percentage greater than’ indicator is just one of many ways to measure market breadth, but is simple and often reflective of other indicators as well.)

All-in-all, the combination of record high levels at arm’s length and market divergences is cause for concern (if you’re long). It doesn’t mean the market will fall from the sky tomorrow, but it does suggest market conditions are growing ripe for a decline. The divergences highlighted can persist for extended periods of time, and if the market is to continue its way higher, additional gains will likely come in a sequence of 3-steps forward, 2-steps back. We will delve into shorter-term charts for cues on to how to handle the market in the near-term as further developments unfold. At the immediate moment we don’t yet have good signaling from either side of the tape.

S&P 500 w/overlays

Whether you are looking for longer-term forecast or educational material to help you better trade the markets, we have many free guides available.

---Written by Paul Robinson, Market Analyst

You can follow Paul on Twitter at @PaulRobinsonFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.