NYSE ADVANCE-DECLINE LINE SHOWS FIRST NEGATIVE DIVERGENCE IN THREE YEARS -- NEW HIGH-NEW LOW LINE IS ALSO DROPPING -- WHY CHRISTMAS MAY BE A GOOD TIME TO DO SOME STOCK TRIMMING

NYSE ADVANCE DECLINE HASN'T HIT A NEW HIGH ... Like most other market analysts, I've been expecting the traditional fourth quarter market rally. On Tuesday, after the Fed hinted that it might be nearing the end of its rate-hiking, I wrote that the two-week correction/consolidation appeared to be ending which would pave the way for higher prices through the balance of December. I also wrote, however, that I didn't think this last move up would be very long-lasting. In fact, I suggested that January might be a good time to start taking some money off the table if the rally lasted that long. Today I'm going to show a couple of reason why I'm not that enthusiastic about the staying power of the the market's latest upmove, and why I believe that it's on weak technical footing. I'm going to show two widely-followed technical measures to show why I'm concerned. The first is the New York Stock Exchange Advance-Decline line. This is one of the most popular of technical indicators. It's a cumulative total of the number of advancing stocks minus declining stocks. Historically, the AD line is supposed to move in tandem with the market. When it stops rising with the market, a negative divergence is being created. That's where we are right now. Chart 1 shows the $NYAD over the last six months. It bounced off its 200-day moving average in late October (when the market stabilized) and has been rising with the market over the last two months. The problem is that it hasn't exceeded its September high when most of the major market averages have. As long as that negative divergence exists, the staying power of the current rally is in question. As usual, there's more to the story.

Chart 1

FIRST NEGATIVE DIVERGENCE IN THREE YEARS... The next two charts compare the two-year trend of the NYAD (Chart 2) and the S&P 500 (Chart 3). They've been moving up together since the last bull market started in the spring of 2003. I want you to look at the last two market corrections that took place in 2004 and 2005. In both instances the two lines peaked around the same time in March of 2004 and 2005 (red arrows). In both instances, however, the NYAD line moved to new highs before the S&P 500. The AD line hit a new high in August 2004 which was three months before the S&P 500 (compare circles). In June of 2005, the AD line hit a new high a month before the S&P. In both instances, the NYAD line led the market higher. To the upper right of Chart 2, however, you can see that the AD line has failed to reach a new high (red line) while the S&P has already done so (green line). That's the first time since the bull market started three and a half years ago that the NYAD line has failed to move to new highs with the S&P. One of the first things market technicians look for in a mature bull market is a peak in the NYAD line. That's because the AD line usually peaks ahead of the market. It's too early to call this a peak. But it's not too early to start getting a little concerned.

Chart 2

Chart 3

FEWER STOCKS ARE HITTING NEW HIGHS ... Chart 4 compares the S&P 500 (green line) with a line that measures the difference between the number of NYSE stocks hitting new 52-week highs minus new lows ($NYHL). In a healthy uptrend, both lines should be rising together. Again, look at the two corrections in 2004 and 2005. In both instances, the two lines fell together. When the 2004 correction ended, the two lines rose together (compare circles). The same thing happened in the summer of 2005. A new high by the S&P 500 saw a corresponding move up in the NYHL line (second circle). Now compare the two lines at the end of 2005. The green S&P 500 line is hitting a new high; but the NYHL line isn't (purple arrow). That means that fewer NYSE stocks are hitting new 52-week highs. Even worse, the NYNH line is dangerously close the the zero line. That means that the number of new 52-week highs barely exceeds the number of new lows. That's not symptomatic of a strong uptrend.

Chart 4

FOUR-YEAR CYCLE TURNS DOWN IN 2006 ... Breadth indicators normally peak before the market does. In some cases, the lead time at tops can be considerable. However, the relatively long length of this cyclical bull market (three and a half years) and the fact that we're more than halfway through a seasonally strong period (November through January) heighten the significance of the negative divergences shown herein. 2005 also marks the third year of the four-year presidential cycle (which last bottomed in October 2002). Historically, the fourth year is the weakest of the four. That would be 2006. To me, that sounds like a lot of reasons to use the yearend rally for some stock trimming as opposed to stock shopping.