Pause In An Ongoing Uptrend?

• The underlying trend of improving confidence continues
• Several indicators are pointing to some kind of a correction
• Small caps are lagging

The underlying trend of improving confidence continues

The longer-term indicators monitoring the primary trend of the US stock market continue to point north. So too, do the various confidence ratios, such as credit spreads, high beta versus high quality stocks and so forth. A great example of this positive sentiment comes from the relationship, between the S&P High Beta and High Quality ETF’s (SPHB/SPHQ). Shown in Chart 1. The green shaded areas flag periods when the ratio is rising i.e. when investors are growing in confidence, as they bid up high beta relative to better quality issues. Recently this relationship broke above a major down trend line, which indicates that it is ultimately likely to move higher.

Chart 1

Another reason for optimism comes from Chart 2, which compares the equal weighted S&P Composite with net new highs for the S&P and NASDAQ Composites. Normally, major highs in the indexes are preceded by a strong cluster of new highs, registered at a preceding and lower peak. In the 2018 period we see the strongest number of net new highs over the course of the rally. That does not rule out the possibility that late January saw the peak of this bull market, but it greatly reduces the odds. Had we seen a fraction of the number we saw last week that would be another matter entirely.

Chart 2

Several indicators are pointing to some kind of a correction

Despite these longer-term favorables, we find the market very overstretched coming into February, so some corrective action, under the context of an on-going bull market, would not be surprising. Remember, corrections can just as easily take the form of trading ranges as actual declines, so it’s not necessarily a big deal.

One of the most outstanding traits of the latest leg of this bull market has been the lack of volatility, best displayed in graphic form by the $VIX. Chart 3 shows that there was a trend of declining volatility between August 2016 and January 2018. That trend appears to have been broken, which suggests that the VIX will likely register a higher number (lower prices) before the market itself registers a new high.

Chart 3

Chart 4 also shows the $VIX, but this time in moving average format. It has also been plotted inversely to correspond with stock price swings. Here you can see a much more definitive trend break, which again suggests that the market has taken on more volatile characteristics.

Chart 4

One of my favorite oscillators is the Dow Diffusion indicator, featured in Chart 5. This one monitors the percentage of Dow stocks in a positive trend. The red arrows point up periods when it has peaked from at or above the horizontal dashed red trend line usually a sideways or downside correction has transpired. The latest sell signal was triggered earlier this week.

Chart 5

Yesterday, the daily KST for the NYSE Composite also triggered a sell signal (Chart 6). Like any tool used in technical analysis this is not a perfect indicator, especially when offering contra trend signals. However, most of the time it works reasonably well, as you can see from the solid red arrows. The dashed one in May points up a failure.

Chart 6

Finally in the oscillator department, Chart 7 compares the performance of the NYSE Composite to that for the bullish percent indicator. The shaded periods indicate when the bullish percentage is below its red 20-day MA. The ellipses reflect false bearish crossovers. The negative ones have been highlighted because the latest signal from this indicator is a bearish one. Most of the time when the bullish percent crosses below its MA this also adversely affects the NYA. However, even when it does not, a declining bullish percent still reflects the fact that the market has become more selective.

Chart 7

That last point suggests that the two trendlines for the NYSE Common Stock A/D Line and the NYSE A/D Line stand a chance of being ruptured. These breadth indicators have performed outstandingly well during the last two years and have confirmed every high in the NYSE Composite. If we do see them ruptured it would not necessarily mean that the NYSE Composite has to suffer that much. However, whenever breadth indicators such as this come under pressure, it reflects that fact that the market has become that much more selective. In other words, the Dow Jones Industrial Average may do well, but Mrs. Smith’s Dow might have a harder time holding up.

Chart 8

Small caps are lagging

Several weeks ago, I wrote that small caps, in the form of the Russel 2K ETF, the IWM, had just broken out and that we should expect the small cap sector that it represents, to perform well. As it turned out, the IWM did move higher, but when compared to the market as a whole this sector has clearly lagged. We can see this from Chart 9, where the relative line, in the third window, failed to confirm the latest high in the price itself. Moreover, it has now crossed below its 65-week EMA and completed a top. To make matters worse, the KST for relative action is declining. The bottom line, is that the trend for the IWM itself remains positive, but the RS line is telling us there are better places to invest than the small cap space.

Chart 9

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.