A combination of three factors suggests the ingredients are present for a notable retracement for the indices.
- There are bearish divergences on the cumulative advance/decline lines.
- The S&P 500 is overvalued.
- Investment advisors remain overly bullish.
On the Charts
All the major equity indices closed higher Wednesday with positive internals on the NYSE and Nasdaq as volumes rose on the NYSE and declined on the Nasdaq.
The S&P 500, DJIA, Nasdaq Composite and Nasdaq 100 all made new closing highs while the Dow Jones Transports, S&P MidCap 400, Russell 2000 and Value Line Arithmetic Index closed above near-term resistance leaving all in near-term uptrends with the exception of the Transports, which is neutral.
So how can we be so concerned regarding near-term prospects?
The answer is cumulative breadth for the All Exchange, NYSE and Nasdaq are all on bearish divergence signals. This is especially obvious on the Nasdaq cumulative A/D (see chart below).
The chart shows the same divergence existed in August 2018 and September 2019 that were subsequently followed by notable corrections in the markets. It is a visual representation of the fact that fewer and fewer stocks are participating in the rallies. This dynamic is coincident with markets that are led by a few select "have to own" names as the market's foundation begins to crack.
On the Data
All of the McClellan one-day McClellan Overbought/Oversold Oscillators remain neutral (All Exchange:+22.12 NYSE:+21.94 Nasdaq:+24.42).
The Open Insider Buy/Sell Ratio at 32.0 remains neutral as does the detrended Rydex Ratio (contrary indicator) at 0.39.
This week's Investors Intelligence Bear/Bull Ratio (contrary indicator) still finds advisors overly bullish at 19.1/47.6.
The S&P 500 is trading at a P/E multiple of 19.4x consensus forward 12-month earnings estimates from Bloomberg $175.13 per share, versus the "rule of 20" fair value multiple of 18.4x, its most overvalued level over the past several months.
The S&P 500's forward earnings yield is 5.18% while the 10-year Treasury yield is at 1.63%.
We believe the advance of the index charts is masking a deterioration of market breadth to levels preceding notable market weakness, while the S&P 500 is overvalued and investment advisors remain complacent.
We don't know when the correction will come. However, we believe the odds of one occurring a reasonably high. Thus, we are keeping our near term "neutral/negative" outlook in place.