ANOTHER MEASURE OF MARKET BREADTH SHOWS NEGATIVE DIVERGENCE
McCLELLAN SUMMATION INDEX ... Yesterday I showed some negative divergence starting to appear between the NYSE Advance-Decline line and the S&P 500. In response to another reader question, today I'm showing another measure of market breadth that's showing a more serious negative divergence. The indicator is the McClellan NYSE Summation Index ($NYSI). [It can be found on the Market Summary page under NYSE McClellan Chart]. First let me explain what it is. Some of you may be familiar with the McClellan Oscillator which is a combination of exponentially smoothed averages applied to the NYSE advance-decline numbers. When the shorter average falls below the longer average, the MO falls into negative territory (below its zero line). An upside crossing by the two averages turns the MO positive. The Summation Index is a longer-range version of the oscillator. The SI rises when the McClellan Oscillator is positive, and falls when the MO is negative. While the oscillator is meant for short-term trading, the SI gives us a longer-range view of the strength or weakness of market breadth. Which brings us to Chart 1. The green line is the NYSE Composite Index which just recently hit a new record high. The red line is the McClellan Summation Index. Both turned up together last October. Since the start of the year, however, the SI has been dropping while the NYSE (and most other market indexes) have been rising. In the past, that type of divergence has usually led to downside corrections.
Chart 1
A LONGER VIEW AT THE SI ... The next chart compares the SI (red line) to the NYSE Index over the last two and half years. The last three peaks in the Summation Index took place at the start of 2004, the end of 2004, and the middle of 2005 (see red arrows). In all three instances, the NYSE kept rallying after the SI peak. In each instance, however, a downside correction started within two to three months of the SI peak. The last peak in the SI took place at the end of January. That would suggest a possible downside correction sometime after the month of April. Notice also that the last three downside corrections ended with upturns in the SI from much lower levels (green arrows). We're nowhere near those earlier levels and the SI is still dropping. There's no guarantee that this negative divergence will lead to another downside correction. But it is a concern that shouldn't be ignored.
Chart 2
HOW TO PLOT THE NYSE AD LINE ... The next chart shows the traditional NYSE Advance-Decline line. It's in danger of falling beneath its 50-day average for the first time since last November. That was the other negative divergence that I referred to yesterday. To create Chart 2 for yourself, type in the symbol $NYAD. Under Chart Type, click on "cumulative". That will give you the NYSE Advance-Decline line. The last time the NYAD broke its 50-day line was last September (red arrow). That correctly signaled the start of a downside correction in the NYSE a couple of weeks later (Chart 4). Both rose back over their 50-day lines after successfully testing their 200-day averages. A drop beneath the 50-day line by the NYAD would simply be another advance warning of some possible selling ahead. A likely time target for a correction to start would would be sometime in May. That would also coincide with the start of the May-October six month span which is traditionally the weakest of the year (leading to Wall Street axiom to "sell in May and go away"). And, as I showed yesterday, the April move to new highs by the NYSE has not been confirmed by the advance-decline line. That makes me suspicious of the staying power of the current market bounce.
Chart 3
Chart 4
