This Divergence Is Visible - And It Hasn't Been Stock Market Friendly

September is known for getting off to rough starts and closing the month with additional weakness, but there is generally some stability in between. Thus far, despite the dramatic nature of the moves, the price action is in line with seasonal expectations. However, we have noticed a few technicalities that suggest an incredibly bumpy ride going into the end of the year. While there could be some short-term upside in the S&P 500 as it catches up with the Nasdaq 100 and seasonality comes into play, the risk of being long and wrong is growing substantially and becomes deafening if the S&P approaches 3,700. It is well known the Nasdaq 100 has outperformed the S&P, mostly because the broader market's performance has largely been driven by a handful of tech stocks that were in the right place at the right time to benefit from the behavioral shift in society. Meanwhile, sectors such and banking and energy have been left behind. If the S&P continues to hold support near 3,280 as it did in the overnight futures session, these weak sectors could play catch up allowing the S&P to continue closing the gap on the tech-heavy Nasdaq in the coming weeks, but the coming months could be troublesome. Source: QST Also contributing to the performance spread between the broader market and tech stocks is technical action; the S&P melted below the December 2018 low on its way down in March 2020, but the Nasdaq managed to hold above it. Yet, on the way up in July 2020, the Nasdaq pushed through trendline resistance that dates back to 2017. The S&P 500 tested the resistance of a similar trading range pattern just last week and failed miserably. Accordingly, the rally from the March lows to September highs has been larger on a percentage basis in the S&P 500 than the Nasdaq (64% vs 44%) but the year-to-date return is lopsided in the other direction (40% vs 10% at the recent highs). In short, the Nasdaq has been more orderly than the S&P on the way down (holding major support levels) but has been less orderly on the way up (breaking through resistance with vengeance), whereas the S&P has performed oppositely. Investors have noticed these characteristics and will continue to behave accordingly until something changes; thus, momentum and FOMO (Fear of Missing Out) have been overriding fundamentals. Source: QST While the Nasdaq powered through trendline resistance in July to new all-time-highs, the RSI on a weekly chart is diverging from the price action. Simply, the RSI (Relative Strength Index) failed to make a new high as the index was doing so. The divergence is even more pronounced in the S&P 500, which is a better gauge of the overall market. For instance, the weekly RSI on an E-mini S&P 500 chart peaked at 72.0 in February 2020 with the S&P valued at just under 3,400 but last week's run to just under 3,600 resulted in an RSI of just 67.0 on a weekly chart. Failure of the indicator to make a new high with prices is generally a sign of froth. We saw something similar in early 2018: The RSI reached 92.0 in January 2018 before a large correction ensued but the subsequent rally of similar heights in September of 2018 saw an RSI reading of just 69.0; shortly after the S&P suffered a large and sharp correction going into the end of the year and failed to make new highs in the index for nearly a year later. In light of the divergence in the RSI, we wonder if the progress we've been seeing in the major indices is simply pulling forward gains, and will be digested for months or possibly longer as was the case in 2018 and 2019. Source: QST With seasonal support and swift support looming at 3,280, we suspect the S&P 500 has a 75% chance at making another run at new all-time-highs in the short-run but should run into significant resistance near 3,660 to 3,700. However, if we are wrong about support at 3,280 holding this time around or the market fails after reaching new all-time highs (as expected), the subsequent corrective selling will likely be hard and fast as we have seen in previous years. The first downside target and support lies near 3,185, which is a pivot level that has acted as both support and resistance in the past. If broken, a slide to about 3,050 is likely. While we aren't anticipating a collapse to 2,750, it wouldn't be impossible and should be acknowledged by the bulls. On the flip side, if we are wrong about the stock market consolidating or wallowing as investors digest the record-breaking volatility seen in 2020, a break above resistance at 3,700 suggests a rally to 4,000 would be on tap, but that is an unlikely outcome for the remainder of 2020.

This Divergence Is Visible - And It Hasn't Been Stock Market Friendly

The risk of being long and wrong is growing substantially.

Columnist Conversation

Worst Stocks to Buy for the Biden Presidency

Thursday Morning Fibocall for 1/21/2021

Best Stocks to Buy for the Biden Presidency

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.