Wednesday, May 18, 2011

Another Little Sign

Is a bigger market sell-off coming? We are currently debating this question in our investment team meetings, and the answer is not entirely clear at the moment. However, there are technical signs that are starting to emerge which are unsettling to the bulls on the team. We have written before on the deterioration in the commodity markets and specifically the copper market which tends to lead stocks, and also the relative weakness in emerging market stocks. In addition, the relative outperformance of the non-cyclical sectors of the market which Carl wrote about last month has continued with increasing momentum. Finally, we have reached the season of selling as the old adage states that it's time to “Sell in May, and Go Away.”

Now a new, albeit smaller, sign has recently caught our eye. The chart below shows the percentage of stocks trading above their 200-day moving average (MA) on the NYSE. The 200-day MA is generally considered the long term average to determine the health of the stock market, and the chart is showing a couple of short term concerns. The first concern is that the amount of stocks over their 200-day MA was unable to break the February peak as the price of stock indexes broke out to new highs (called a bearish divergence). The second concern is that the number has broken below the March low, and now stands at a new 2011 low of 68% of stocks trading above their longer-term MAs.

The evidence still leans bullish overall as the long term trend is still healthy, momentum has not entered bearish territory, and most breadth indicators have not deteriorated. But more cracks are starting to appear. As a result we have started our sequencing process which Ken wrote about on Monday, and we will continue to monitor the health of the market in hope that the cracks will heal. But since hope is not an investment strategy, we will be prepared to act if necessary.