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Yesterday I wrote about the deterioration in market leadership and how this is the first stage of a top. If you missed that, go read it now as the following will make more sense.
As less and less individual stocks power the market upwards, the responsibility is shouldered by fewer and fewer stocks until they too falter. And that’s when the rally ends. Before mentioning another piece of evidence to prove this is happening, here is a quick update of the chart I showed:
While most are attributing the declines to the Dubai debt debacle, I seriously doubt that’s the catalyst. The market was very top heavy and any excuse to sell would have served. In any case, now the S&P 500 is 15.65% above its long term average. And the BPI for the Nasdaq dropped slighly to 57.4%
BPI for the S&P 500 fell to 76%.
The evidence that the rally is becoming concentrated in fewer and fewer constituents is apparent if we compare the chart of the ‘normal’ S&P 500 index which is capitalization weighted to the equal weighted S&P 500 index:
Since these are long term charts, it may be difficult to see the hard right edge but the equal weighted index has not been able to reach a new high in November, like its cousin the capitalization weighted index.
This is the same divergence which we saw at the top in mid to late 2007 and at the 2000 top. In each instance, while the rally continued in the index that has the largest audience, being featured in the news, in the corner of TV screens and at the top of so many websites, the equal weighted index either fell or was unable to follow.
On its own, I don’t usually give much attention to this sort of divergence. But when it is confirmed by other metrics, as it is now, then it is a good cautionary sign. To be clear, this does not mean that the spring rally is over. While it may very well be, this specific measure can take weeks to months to play out.
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