A NUMBER OF NEGATIVE DIVERGENCES SUGGEST MORE VOLATILITY AHEAD
TECHNICAL DIVERGENCES WARN OF MORE VOLATILITY... We're all focused on the meaning and severity of the recent selloff in stocks and trying to determine if this is a short-term pullback or something more serious. A number of technical divergences that have appeared on price charts suggest that the stock market is likely to experience more volatility over the next couple of months. That increased volatility could lead to lower stock prices or, at the very least, a period of choppy trading. Charts 1 and 2 show two of those negative divergences.
% OF SPX STOCKS ABOVE 50-DAY AVERAGE WEAKENS...The blue line in Chart 1 plots the percent of S&P 500 stocks trading above their 50-day moving average. The blue line bottomed with the SPX during the spring and moved into overbought territory over 90% during June. After a period of consolidation, both started rising again during July. While the SPX hit a new record, however, the blue line remained well below its June peak which formed a negative divergence between the two. This week's selling pushed the blue line to the lowest level in two months. The value of the blue line sits at 53% and is nearing a test of its June low. A drop below that level would signal more weakness. The main point of the chart, however, is to highlight the negative divergence that signaled that the summer rally was taking place on shakier technical ground. And is vulnerable to a period of choppier trading ahead.
% OF SPX STOCKS ABOVE 200-DAY AVERAGE ALSO WEAKENS...The red line in Chart 2 plots the percent of S&P 500 stocks above their 200-day moving average. The main point of the chart is to show the red line failing to exceed its June peak over the last month while the SPX was setting new records (red arrow). That negative divergence also warns of potential weakness ahead. The present value of the red line is 59% which means that 41% of the SPX stocks are already trading below their 200-day lines. That's an unusually high number in a market that hit a new record just a week ago. That negative divergence also suggests that stocks are vulnerable to more selling.
NASDAQ 100 BULLISH PERCENT INDEX WEAKENS... A number of negative divergences are showing up in other technical measures. The red line in Chart 3 plots the Bullish Percent Index for the Nasdaq 100. The BPI measures the percent of stocks in point & figure uptrends and is a good measure of market breadth. And right now it's signalling weakness. The red trendline shows a series of declining peaks in the red line over the last three months as prices continued to advance. Over the past week, however, the BPI line has fallen to 41% which is the lowest level since March. That's another warning that more selling may lie ahead. The fact that stocks have entered a period of seasonal volatility that could last through the coming election also suggests a more defensive attitude on stocks.
