Entering Critical Season – Warning Signals Are Increasing

In our December 2016 outlook (A Look Ahead – Outlook H1 2017) we warned of a market top most likely in July/August. This is when the presidential and the decennial cycle turn bearish. Also, several of my most recent comments were about market breadth and the typical signs of major market tops.

As June is nearly over,  it is time to have a look at equity markets again.

Index divergences are one indication of a pending market top. Currently, the Dow Jones Transport Index still does not confirm the recent new high in the Dow Jones Industrial. Rembember, such a non-confirmation preceded the correction from 2015. Also the recent weakness in tech indices such as the Nasdaq and the Semiconductor Index is often a warning signal that something is wrong.

I have also talked about the percentage of stocks that reach a new 52-week high. In early June, when the S&P 500 reached a new high, 28% of all the index members traded at a new 52-week high. This compares to only 18% at the day of the most recent high (June 19th). In other words, the participation is falling. The index is lifted higher by fewer and fewer stocks.

We see a very similar picture in the percentage of stocks that are trading above the 200 day moving average. Since early March, this number is constantly falling, despite new highs in the S&P 500.

A mixed signal is coming from the advance-decline ratio. While the advance-decline line continues to move higher (good news), advance-decline volume does not confirm new highs in the index anymore.

All this, coupled with a divergence in the RSI, makes me increasingly worried that our prediction of a top in July/August might become true. The two cycles suggest, that we will have to go through a correction that could last until October. My feeling is that the July/August will not yet be THE top of this bull market. Following a low in October, we should see another attempt to new highs, accompanied by further lagging market breadth. Remember, major market tops form over the course of many months and bull markets almost never end abrupt. The toping process has started!

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