Please note I am writing this early on Wednesday morning rather than after the market close as I normally do. Therefore, today’s data will not be included in any of the charts.

The market broke out yesterday. Is it time to get excited? Not in my view. In fact, other than the price of the S&P 500 hitting a new high yesterday, I saw predominantly bearish signs. Let me first discuss some of the characteristics of market tops. Unlike market bottoms that often occur with capitulation selling and sharp reversals, tops are more of a slow process. Two primary characteristics of topping formations are declining momentum and declining breadth. Yesterday’s action further confirmed we are seeing both.

Momentum can be measured a number of ways. On the chart below of the S&P 500, I have included two momentum indicators -- RSI and MACD. I have also marked with horizontal lines the Jan 11, Feb 27, and yesterday’s highs. What you will notice is that both RSI and MACD have made lower highs while the S&P has made higher highs on each of these days. This is a negative divergence and not a good sign.



Now let’s look at breadth. Breadth measures what is going on under the hood. In a study released by Lowry’s in January, they discussed the fact that the vast majority of individual stocks top out before the market does. Of the 14 market tops they studied, they found that, on average, only about 6% of stocks made new highs on the day the market made its final high. (Yesterday about 5.4% of the NYSE hit new highs.) Further, they found that in most cases a significant number of stocks were already substantially lower (20% or more). They concluded that breadth deteriorates before price when looking at the indices. Let’s look at some breadth indicators that many of you may not follow. (In all these charts I have marked the Jan 11, Feb 27, and March 14 new high days with red arrows):

This first chart shows the number of new highs divided by the sum of new highs plus new lows:



Note the deterioration at each new high.

This 2nd chart shows the percentage of NYSE stocks trading above their 40-day moving average:



From 82% in January to 57% yesterday. That is some significant deterioration.

Now let’s look at the percentage of stocks that are on the rise and trading at least 1 standard deviation above their 40-day moving average.



Again -- substantial deterioration.

Finally, let’s look at the percentage of stocks that are on the decline and trading at least 1 standard deviation below their 40-day moving average. This should give us an idea of how much selling is really occurring.



While the number of up trending stocks has been declining, the number of down trending stocks has been increasing. Even though the market hit a new high yesterday, over 22% of the stocks on the NYSE are trading at least 1 standard deviation below their 40-day moving average.

Declining momentum and declining breadth do not bode well for the market. While there may still be some life left in this rally, it is getting weaker and weaker. I don’t think the next correction is too far off, and for many stocks, it may already have begun. Finally, you should also note that even with the big rise and new price high yesterday, volume stank -- another bad sign.

Best of luck with your trading,

Rob
RobHanna@comcast.net

For those who may be looking to expand their knowledge beyond just market timing, my Hanna ETF Money Flow System utilizes the VIX in generating trading signals for spread trades.

Rob Hanna is the principal of a money management firm located in Massachusetts. He has spent the last several years developing and refining methods for trading in stocks across multiple time frames. He selects stocks using both fundamental and technical criteria, and then trades them using technical analysis techniques.