US Stocks Looking Vulnerable Again

• Long-Term Picture Remains Finely Balanced
• Short-Term Indicators Still Showing Weakness
• Confidence is Starting to Erode Again
• Financials Break Down from a Broadening Wedge

Earlier in the month, I wrote about the Ides of March and the fact that the market looked overstretched, apparently in need of some mean reversal corrective activity. The market immediately thumbed its nose at my prognostications and moved slightly higher. However, it has since returned to those same levels. For the record, the NYA and DIA are down a little, while the $SPX and $COMPQ are up slightly. Unfortunately, the technical position has deteriorated somewhat, so US equity prices continue to look short-term vulnerable. What makes things even more interesting, though, is the fact that the long-term indicators are offering a very mixed picture, wherein some near-term weakness could tip the balance in a bearish direction. I've been looking for a test of the December low, but the way in which that process might unfold could be of crucial importance going forward.

Long-Term Picture Remains Finely Balanced

Chart 1 for instance, compares the S&P and the NYSE Composites to their 12-month MAs. Bullish and bearish crossovers don’t work every time, of course, but the the 12-month span, which eliminates seasonal fluctuations, is one of the most consistent. Such crossovers, therefore, provide a fairly accurate and objective measurement of the direction of the primary trend. The arrows in Chart 1 show that there have been very few whipsaws since 2005. Second, both series moved above their respective averages in February, but are still very close to them. Remember that the latest plots do not count, as they are not based on end of the month data but merely a third week of the month “estimate.” Trading during the last five sessions of March could tip the balance of this reliable indicator one way or the other.

Chart 1

Short-Term Indicators Still Showing Weakness

One of the striking characteristics about the post-December rally has been the very strong performance of market breadth, which has enabled the NYSE A/D Line to register a new all-time-high. That was also true for the NYSE A/D Line constructed only from common stocks, as we can see in Chart 2. Note that, when the NYA touched its recovery high in mid-March, the A/D Line failed to confirm this action. In effect, we saw a repeat of the same characteristic seen at last September’s high. That weakness was confirmed when both series violated their respective red solid uptrend lines. So far, only the A/D Line has punctured its recovery uptrend line. However, it’s fairly apparent that price action during the last week of March will be crucial, as the NYA and the upside/downside volume line are right at their respective trend lines and the NYA is also positioned marginally above its 200-day MA.

Chart 2

We see another short-term divergence in Chart 3, this time between the NYA and the NYSE bullish percentage. That divergence is compounded by the fact that the bullish percent was unable to rally above its 20-day MA. A similar divergent setup developed during the summer of 2018. That one was confirmed by a trend line violation for the NYA, but so far that has been the case this time. One thing is clear, which is the fact that, since the January 2018 peak at “1,” each rally high in the bullish percent at “2” and “3” took place at a progressively lower reading. This characteristic further underlines the shrinking participation that has been developing during the last year and a quarter.

Chart 3

Chart 4 also makes the same point, as it compares the $SPX to the percentage of its components that are above their 50-day moving average. The red arrows indicate that overstretched reversals in this indicator are typically followed by a correction of some kind in the $SPX. That indicator topped out some time ago and dropped as the average rallied to its recent peak. That decline in the indicator clearly represents a negative divergence. Moreover, the sharpness of the drop underscores the fact that the post-December advance is being fueled by fewer and fewer issues.

Chart 4

Confidence is Starting to Erode Again

The ratio between high yield bonds (HYG) and 7-10 year treasuries (IEF) reflects the opinion of bond investors as to whether economic conditions are likely to improve or deteriorate. When it is rising, that tells us that traders are more interested in the yield being offered by junk bonds than they are in the relative safety of the lower yielding treasuries. A falling relationship, on the other hand, tells us that these savvy investors are now more concerned about the possibility of default, as they turn to the safety of government bonds.

Chart 5 tells us that, most of the time, the ratio moves in the same direction as the stock market. However, there are times when it does not; those instances warn us to the possibility that the prevailing trend may be about to reverse. One example appears to be developing right now; the ratio failed to confirm last week’s high in the S&P and has subsequently completed  its 2019 top. It has also dropped decisively below its 50-day MA. The S&P has started to confirm with a marginal trend line violation of its own. That’s not enough to conclude beyond a reasonable doubt that a break has taken place, but any additional weakness whatsoever will.

Chart 5

Financials Break Down from a Broadening Wedge

One of the weakest sectors since the March 19 recovery high has taken place in the financial sector. Chart 6 shows that the SPDR Financials, the XLF, has completed and broken down from a broadening wedge. A regular wedge is formed from two converging trend lines drawn in the opposite direction to the prevailing trend. It is considered to be a continuation pattern. Broadening wedges, on the other hand, are constructed  from two diverging lines, where the ever-widening trading range identified by this formation reflects greater and greater instability. Such patterns are usually followed by an above average move. That seems to be a very real possibility in the current situation, as the price is also back below both its 50- and 200-day moving averages.

Chart 6

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.