Signs of Fatigue

In many ways, Tuesday was the opposite of Monday. The S&P 500 gained only 0.4%, but the day’s internals were relatively strong. Common stock breadth was positive by a 4:3 ratio, which was its second best performance in the past six days. Upside volume outpaced downside volume by a similar ratio.

However, total volume has been below its 21-dma for 16 straight days, which is its longest such string since last August. The total volume difficulties are aggravated by signs that near term momentum is peaking and by the fact that a sizable number of stocks have pulled a good distance away from their rally highs. Near term momentum has been constructive since late May and has, therefore, been in sync with medium term oscillators, which have had a bullish bias since March. But it now appears that the near term oscillators will peak in the next day or two. If so, this will be the second lower high since the “good overbought” condition recorded in late March. Since the intermediate indicator is still on pace to peak by late June or early July, it is becoming less and less likely that the post-March trend will be able to withstand a near term pullback. Increasingly, the risk is that a near term correction will prove to be a full blown reversal.

S&P 500

As near term momentum fatigues – and diverges – more and more stocks are pulling away from their post-March rally high. At Tuesday's close, more than one-quarter of NYSE common stocks were more than 10% below their rally high. At the initial rally high in early May, only 16% of common stocks were in that situation.

All of this suggests that there is increased evidence of important deterioration. So far, it is of the near term variety, but the rally is mature my almost any measure. Continued near term deterioration will undoubtedly morph into something more important. Moreover, even if the S&P moves to higher highs, there will likely be signs of increased negative divergences. Under those circumstances, such a rally would likely prove to be an ending phase, not a renewal.

With all of the above in mind, a reversal of momentum, together with a breach of the trend line and a violation of 923 (our first support/trading stop level), will be viewed as a distinct negative. For now, our resistance focus remains on 982.