Internal Weakness Means Caution Is Warranted

As curious investors, we need to know that the performance of stocks within an index is just as important as the performance of the index itself. And when the two aren’t confirming each other, it is time to sit up and take notice. For the past six months, if not longer, we’ve been witness to that scenario. While the S&P 500 (a major U.S. Stock barometer) has been gaining ground since July 2014, the individual stocks within this index are not participating at the same pace. This is called a thinning (or stock pickers) market and could be a harbinger of a change in direction for the overall market. This is just a warning sign. Something to be aware of. We don’t need to take action… yet. We just need to be aware that things are not as they seem. This symptom can resolve itself with an increase in stock participation. If that happens, it means great things for the upward trajectory of the market. However, if this symptom does not resolve itself, any downturn in the market could be significant (a 10 to 30+% correction).

Let’s take a look at what’s happening. The chart below is pretty simple. The line above is the percent of S&P 500 stocks that are above their 200 day moving average. Notice that a less and less percentage of stocks are above their 200 DMA. The line below is the S&P 500 itself. Price is near new highs, but fading. I’ve annotated (in 360 green) where past divergences have taken place. Notice the eventual reaction of the market. It doesn’t tell us when, but simply, that a resolution must take place. As you can see, the current divergence has been in place for a significant amount of time when compared to similar occurrences in the past eight years. We’re taking notice as we weigh the evidence. Do we think a major correction is upon us? Maybe. We don’t trade on maybe, but caution is warranted. We trade on price and we’ll be watching it closely to see what our next move should be.

Stocks above 200 DMA divergence

Disclaimer: Nothing in this article should be construed as investment advice or a solicitation to buy or sell a security.