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Losing The Generals: Market Leadership Deteriorates at Trader’s Narrative

The stock market has been meandering uphill at about the same pace as its long term trend line. While bound by the invisible ‘maximum’ 20% gap between it and the 200 day moving average, it has been able to slowly meandered higher as the long term moving average rises concomitantly.

Mind the Gap
Here is a chart that I showed before (What Happens This Far Above The 200 Moving Average?) zoomed in for the past few months:
distance from 200 MA SP500 Sept-Nov 2009

From the first incursion above 20% in mid September, when the S&P 500 was at 1069, the index has been able to claw its way +4%. Meanwhile, the 200 day moving average (not shown) has risen 5.6% in the same time period, closing the gap slightly.

Your Breadth Stinks
However, even as the major indices like the S&P 500 and the Nasdaq Composite have been able to peek higher in November and make new highs for the year, there is an unmistakable deterioration in the underlying momentum. I’ve already touched on this last week: New Highs For The Year But Market Breadth Stinks, but this is an important concept so let’s delve into it a bit more.

Having covered this from the perspective of advance decline or breadth, let’s take another tack by looking at the divergence in the Bullish Percent Index.

I’m usually reticent to rely on divergences since they are found with little effort in almost every single chart (if one just looks hard enough for them). But I’ll make an exception this time since this particular instance confirms what we’re seeing from other market internal measures.

point and figure buy signal.pngBullish Percent Not So Bullish
For those unfamiliar with bullish percent charts, they measure the percent of stocks giving a buy signal in point and figure charting. For a stock to be in a buy signal, it has to be in a very strong technical formation, having surpassed a recent high. So if the bullish percent for an index is lower, then fewer and fewer stocks are acting strong enough to give off buy signals, which means a deterioration in the underlying components. Of course, when bullish percent indexes reach extremes, either low or high, then the trend exhausts itself and reverses but we’re not concerned with that right now.

Here is a chart of the Nasdaq Composite along with its Bullish Percent Index:

Nasdaq and Bullish Percent Index divergence Nov 2009

As you’ve noticed, while the Nasdaq has made new highs, its BPI has fallen from the 88.6% high it made in mid September to 77.4%. This is similar to what happened in 2007. Even as the index was able to reach new highs, the BPI drifted lower, exposing the fact that less and less component stocks were responsible for the points gained in the index.

And here is the chart of the S&P 500 index along with its BPI showing the same divergence:
S&P 500 and Bullish Percent Index divergence Nov 2009

I’d prefer to see a significant correction so that the BPI is given a chance to ‘reset’ by losing the elevated level (see August 2007). From there, it either rises again or it continues to droop lower. If it rises, then it confirms the new high (and the participation of most components in the rally). But if it continues to atrophy, then we’ve got a major and continuing divergence.

But remember, while fewer and fewer stocks shoulder the responsibility of continuing the rally, it doesn’t automatically spell the end. An index can move higher for weeks and even months with fewer and fewer participating constituents until it ultimately succumbs to the inevitable. That’s why tops are usually lethargic and round while bottoms are sharp and shocking.

Tomorrow, I’ll cover another measure of market internals which is also pointing to the same deterioration of market leadership.

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