US Stock Market Breadth Deteriorating

Something very unusual, for the year 2017, happened last week with the S&P500 — it fell for the second consecutive week.  The large cap index dropped 0.65% on modest volume. But volatility, while rising mid-week, failed to close higher than it did the previous week.

The technical picture continued to deteriorate. By Friday’s close, the S&P was firmly below the 50 day moving average. Momentum, as measured by MACD, continued to weaken. That said, the 50 day moving average is still solidly above th 200 day moving average and prices are still well above the 200 day moving average. So the strategy that’s worked well for many years now—buying the dip—has not broken down. If prices approach the 200 day moving average, an entire school of traders and investors may once again jump in with fresh buying. The risk of course is that some day this strategy will fail….and all these dip buyers (which by now means most of the folks and machines in the market today) will be spectacularly wrong; the expected rebound at the 200 day will fail to materialize and a big break—downward—will ensue.

On the US economic front, last week’s reports were mixed. Retail sales, the Empire State manufacturing survey, business inventories, the Philly Fed survey and consumer sentiment all beat expectations. On the other hand, housing starts, industrial production and leading indicators missed or only met expectations. Last week was a bit stronger than usual, but one week’s results don’t make for a trend.

Finally, many market observers are pointing out that while S&P prices (despite the recent decline) are still clinging near all-time highs, market internals are rapidly deteriorating. For example the percent of stocks in the S&P that are trading above their 150 day moving averages has fallen steadily during 2017….at the same time the overall price index has moved higher. Also, the new highs minus new lows is now firmly negative (meaning more stocks are setting new lows than are setting new highs).

All this means that the overall price index is being held up by fewer and fewer large cap market leaders, such as Facebook and Google and Amazon. And in the past 100 years, all major market corrections were preceded by a similar deterioration in market internals. Of course, this deterioration is not a sufficient condition (ie. it’s not the only thing that happens before major market losses ensue), but it’s a necessary condition (ie. it’s one of several key conditions that must be in place for major market losses to happen).

And this condition is now in place.

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