Divergences abound in the current market

In

a recent article, I proposed a simple indicator. Look over the past 20 days
and subtract the number of days in which we've made a 20-day low from the number
of days in which we've made a 20-day high. There's no question we've been
strong on that measure in the S&P 500 Index. We've had no 20-day lows in the
past 20 days, and we've had nine highs.

Ah, but strength does not always bring strength.
Since 2004, my research found that market returns are subnormal--and actually
negative over the next two weeks--when we've had five or more new 20-day highs
than lows. When new low days have outnumbered new highs by five or more over a
20-day period, market returns have been extremely bullish.

But it's not just market strength that has me
concerned. I also notice strength in the large cap indices that isn't being
matched by strength elsewhere. Consider the following:

• This week, so far, we've seen a maximum number
  of 1239 stocks register fresh 20-day highs. The week before we had 1498. The
  week before that, we hit 1622. (Kudos to
  the Barchart site for these numbers).
  
   


• The Russell 2000 Index ( IWM | Quote | Chart | News | PowerRating) is off its highs
  from last week and well off its May highs, even as the S&P 500 Index is making
  fresh bull market highs. Midcap stocks ( MDY | Quote | Chart | News | PowerRating) are similarly off their May
  highs, as is the NASDAQ 100 ( QQQQ | Quote | Chart | News | PowerRating).
  
   


• The Energy sector ( XLE | Quote | Chart | News | PowerRating) is well off its
  bull market highs. Also failing to make new 20 day highs recently were the
  Financial ( XLF | Quote | Chart | News | PowerRating), Consumer Staples ( XLP | Quote | Chart | News | PowerRating), Healthcare ( XLV | Quote | Chart | News | PowerRating), and
  Semiconductor ( SMH | Quote | Chart | News | PowerRating)
  sectors.
  
   


• Dow Transports ( TRAN | Quote | Chart | News | PowerRating) and Utilities ( UTIL | Quote | Chart | News | PowerRating)
  are both well off their highs.

How broad is the large cap rally? Consider this:

• On Thursday, only 37 of the S&P 500 stocks
  made annual new highs. That figure was 46 the day before that and 48 on
  Tuesday. Just two weeks ago, we had well over 60 new highs among S&P 500
  stocks. In March, we had well over 90 new highs.
  
   


• Four Dow Jones Industrial Average stocks out
  of the 30 made new 52-week highs on Thursday. That was down from six the
  previous two sessions and down from eight two weeks ago.
  
   


• NASDAQ large caps? Only four of the 100 in
  the NASDAQ 100 Index made new highs on Thursday, down from six the previous
  day and nine two weeks ago. In March we had over 15 new highs. (Hats off to
  the Decision Point site for
  tracking these numbers).

The bottom line is that a narrowing base of large
cap issues, highly weighted in the major indices, are carrying this market
higher. As we look from the March-May period to the present period and even
within the last few trading sessions, the rise is becoming more selective.
Every piece of research I have conducted suggests to me that, on average,
intermediate-term market returns are subnormal following such extended
narrowing.

Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of

The Psychology of Trading (Wiley, 2003). As Director of Trader
Development for Kingstree Trading, LLC in Chicago, he has mentored numerous
professional traders and coordinated a training program for traders. An active
trader of the stock indexes, Brett utilizes statistically-based pattern
recognition for intraday trading. Brett does not offer commercial services to
traders, but maintains an archive of articles and a trading blog at
www.brettsteenbarger.com and a
blog of market analytics at
www.traderfeed.blogspot.com. His book, Enhancing Trader Performance,
is due for publication this fall (Wiley).