Market Leaves Trail of Minor Divergences

 | Oct 12, 2017 | 6:00 AM EDT
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IWM

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QQQ

There has not been a lot of change in the market since Monday, but there are now some small, minor negative divergences. Thus far, they remain minor mostly because so far breadth has not rolled over and, as I explained the other day, if breadth is strong it is hard for the market to go down hard. And yes, I still expect we'll see some short-term volatility.

Let me start with the ratio of the Russell 2000 ETF (IWM) to the PowerShare QQQ (QQQ) . The Russell 2000 has been red (barely) for four of the last six trading days. Nasdaq has only been red once in the last 12 days so the ratio has fallen. And recall that when the ratio heads down, volatility tends to pick up.

It matters because, as I noted in Monday morning's column, by the time mid-July came around, this ratio was halfway down the page; you can see that all the indexes remain at the highs but the ratio is now lower than it was a few days ago. This is a change.

As for the minor negative divergences, the number of stocks making new highs has not increased at all this week despite the new highs in the S&P 500 and Nasdaq. But more than that, the number of stocks making new lows on Nasdaq (not the NYSE) has ticked up modestly, something we haven't seen in almost a month. Once again, notice that is what happened in mid-July prior to the August downturn.

On the sentiment front, the Investors Intelligence bulls finally scooted over 60%. Typically, a move over 60% means upside is now limited and downside is likely. But more than that, the ratio of bulls to bears has ticked over 4. You can see there were a series of these readings over 4 in 2014 and 2015.

Not shown on the chart below is the reading from the last week of December 2013; when the calendar turned to 2014 we slid and slid hard. The chart below of 2014 shows the three readings we had that year over 4. The takeaway is that in all three cases it took a few weeks for the market to care, but care it did as you can see.

In 2015, there were two such readings. The first one was almost immediate in that it took a week before the market corrected. In late April, it corrected and made a new high in short order, but I have only shown the S&P 500 through June; in August that year, we saw the market down 10% in a matter of a few days. The upside was limited and three months later we'd had quite a spill.

We already know the Fear and Greed Index got over 95, which is too high. We know the S&P 500 Daily Sentiment Index got over 80 last week (currently 86) and now Nasdaq has finally joined the S&P 500 with a reading at 80.

The main positive is that breadth has not rolled over or gone negative. If it had, I would turn cautious. For now, I would say it's just probably not a good time to add to new longs unless you are willing to use a tight stop. If breadth rolls over, I will turn more cautious in the near term, therefore breadth remains key.

For more market analysis from Helene Meisler, sign up for Top Stocks, published five times a week. 

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