A Negative Divergence Worth Noting

May 8, 2014

2 minute read

Coming into the new year, there were plenty of reasons to be bearish about the US stock market. I’m not going to go over all of them here because you can go back and read what I had to say back then. But one of the most important characteristics of this market, its breadth, has been diverging negatively for some time. My friend Josh Brown touched on this topic today and influenced this follow up post.

The chart that has really annoyed me is the list of NYSE 52-week highs compared with the price of the S&P500. As cliché as it might sound, this is a “market of stocks”, and not necessarily a “stock market”. For S&P’s to continue to make new highs, more and more stocks need to hit new highs; not fewer.

This is a daily line chart of the S&P500 going back over a year. Behind it is an area chart representing the list of new 52-week highs on the NYSE smoothed by a 5 periods to clear our some of the noise. This bearish divergence simply cannot be ignored:

These divergences can be seen in both directions. If you go back to 2008/2009, as the S&P500 was getting crushed, the list of NYSE 52-week lows peaked in October of 2008. After a brief rally, when S&Ps made new lows into November, fewer NYSE stocks hit a new 52-week low. The breadth of the market was already improving. Ultimately at the final low in March of 2009, most of the stocks on the NYSE had already put in their bottoms. The components of the market were telling us that things were improving, although the headlines still read, “S&P500 hits lowest levels since 1996″.

These days, as you know, the headlines have read, “S&P500 closes at an all-time high”. But we know that the actual breadth of the market has been deteriorating for some time. Just like in 2008/2009, I think this divergence will lead to a major reversal in trend. In this case, that would mean lower prices for the S&P500.