FIRST QUARTER SUPPORT LINES ARE BROKEN -- WATCHING SMALL CAPS FOR SIGNS OF A TOP
S&P 500 AND DOW BREAK SUPPORT LINES ... Although the S&P 500 closed slightly below its 50-day average, it was the only one of the major stock indexes to do so. That, however, isn't my main concern with today's action. My main concern was the breaking of rising trendlines drawn under the first quarter lows. And the fact that today's price drop came on rising volume. Chart 1 shows the S&P 500 SPDRs (SPY) having broken the rising trendline drawn under its February/March lows. That suggests that the latest upleg that started during the first quarter is over. The last red volume bars show two distribution days out of the last three. A distribution day occurs when prices fall on rising volume. The daily MACD lines remain on a short-term sell signal. Chart 2 shows a similar pattern for the Dow Diamonds (DIA). The DIA broke its first quarter trendline as well on rising volume. It closed right on its 50-day line. The 12-day Rate of Change (ROC) line at the bottom of Chart 2 has already undercut its March low. That suggests that short-term momentum is weakening.
Chart 1
Chart 2
WATCHING THE RUSSELL 2000 ... When looking for possible signs of a market top, I find that sometimes it's better to look at what's been holding the rest of the market up. In this case, it's been the small cap stocks. . The daily bars in Chart 3 show the relatively uninterrupted rally since last October in the Russell 2000 Small Cap Index. Notice, in particular, that each RUT pullback over the last six months bounced off its 50-day moving average. More specifically, that occurred on the first day of the new year and again in early March (blue circles). The RUT ended today just four points away from the 50-day average. A close below that support line would be added confirmation that small caps have peaked for now and, most likely, the rest of the market. Adding to the likelihood of that happening is the downturn in the daily MACD lines over the last two days. Notice that this latest MACD "sell signal" took place from a lower level than the previous sell signal in early February (red circles). That's adds a negative divergence to this week's downturn and makes this latest sell signal a little more serious. Small cap selling is already starting to hurt market breadth.
Chart 3
Chart 4
NYSE ADVANCE-DECLINE LINE IS WEAKENING... I recently wrote an article showing that the rising NYSE Advance-Decline line owed much of its strength to the strong performance of small cap stocks . That's because there are more small stocks than large stocks. I also showed a close correlation between small cap performance and the AD line. That's why it comes as no surprise to see the NYSE AD line starting to weaken right along with the Russell 2000. In fact, the NYAD line broke its 50-day moving average today for the first time since rising over it last November. That increases the odds that small caps stocks are about to do the same. It also tells us that the market rally that started last October has probably run its course. The combination of rising energy prices and rising bond yields is a tough combination for the market to beat. The fact that seasonal trends turn less friendly after April may also be encouraging some profit-taking.
