Over the course of this year I’ve been consistent in repeating that I didn’t think the market could suffer a correction unless breadth broke down. Even though many other indicators have warned on and off this year, breadth has held strong. This week the picture changed a bit.
First let’s look at the breadth indicator that warned first. The ratio between the S&P 500 Equal Weight Index (SPXEW) and the S&P 500 (SPX) warned in early July when it broke below its 20 week moving average. It turned back up this week but as a result of large caps selling faster than small caps. When a ratio turns up I like it to result from upturns in the numerator and denominator so this upturn isn’t exactly positive.
The NYSE Advance/Decline line (NYAD) is currently experiencing its largest decline in a year. This indicator shows that since the first of July there has been broad based selling as more stocks are declining than advancing. Other declines in the market this year were merely rotation from one sector to another and as a result NYAD held up. This indicator is currently warning that investors are less comfortable holding stocks of any kind. I’m seeing the same symptom show up in social media sector strength where almost every sector had negative sentiment on Twitter last week. If NYAD continues to decline or paints a negative divergence with price on the next rally it will be very concerning.
The bullish percent index (BPSPX) shows how fragile many charts were as the market was making all time highs. A 3% drop in SPX caused 11% of stocks to break down from bullish point and figure chart patterns. This is similar behavior to what we witnessed in February/March.
The percent of stocks in the S&P 500 Index above their 200 day moving average suffered even more damage. The 3% drop in SPX caused 22% of stocks to fall below their 200 dma. This is very concerning and highlights how few stocks are moving substantially higher with the market. If the percent of stocks below their 200 dma and the BPSPX fall below 60% it will warn that the selling could accelerate as longer term investors start evaluating their holdings…and not liking what they see.
The market is higher than it was in March but the the number of new lows on NYSE is higher. This is another indication of more broad based selling.
As an indicator of risk, I’ve been mentioning since early July is the divergence between high quality bonds (LQD) and junk bonds (JNK). Risk off…in a big way.
As I’ve mentioned before, tops are a process and we often see one indicator fall after another over the course of several weeks before the top is in place. We’re now very close to to the point where the weight of the evidence will point down. Our core indicators are all still positive, but our risk indicator is close to a signal. As a result, any changes to our portfolios will be a result of the risk of a steep acceleration downward.