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Today an important gauge of market breadth reached an extreme that it hadn’t seen since April 2010 - just before the stock market in general topped out. The bulls have been attempting to recover since then, putting in unexpectedly strong September.

The metric I’m referring to is the percentage of stocks in the S&P 500 index which are trading above their own 50 day moving averages. I wrote about this way back in late March when I first started to caution you about an impending top (When the Stock Market Goes Streaking):

Based on this and other indicators (like the options trading activity and the amount of froth from speculative trading), I do think we are at or very close to a top here. The market may move ahead a bit more but like other times, it will quickly give that all back and more.

That was exactly what happened. The S&P 500 index went on to tack another 40 points before peaking just below 1220. Technically, when I wrote the cautionary note in late March, the percentage of S&P 500 components above their 50 day moving average was still below 90%. This seems to be the threshold at which stocks hit a wall - with one exception, which I’ll explain a bit later.

With today’s strong showing, the bulls pushed the breadth measure to 91%, the highest it has been since April 16th. So while the gains may seem impressive, just as they were in late March, I’m growing wary of what is coming around the corner.

Click for a larger version of chart:

There are two important caveats I should mention. First, NDR actually considers this development to be very positive for the market. They were in fact saying this in mid-April: A Very Rare Breadth Buy Signal From NDR. I’m leery of disagreeing with any research firm of this caliber but I think I spot why we disagree.

This brings me to the second caveat and the exception I mentioned before. While this breadth measure is a reliable indicator of market tops, it does fail spectacularly at times. As all oscillators, there are instances where it gives us a reading of extreme overbought and the market continues to power higher in spite of it.

These are time periods of very powerful thrusts which propel stocks higher than anyone suspects and feed off a feedback loop that is self-reinforcing. But they tend to be rare as the conditions necessary to induce them only occur every once in a while. We last saw this in April 2009 (not shown on chart) just as the market was lifting off a very oversold condition.

This is an important distinction to make. That is to say, is the current market displaying characteristics of a powerful thrust? or are we in a ‘normal’ market? If the first, then overbought signals, like this one, are meaningless. If the latter, then we are indeed due for a pullback, returning us back into the summer range.

From a technical perspective, I’m not seeing too many signs right now that we are in a momentum market. The other clue is that while in April the percentage of S&P 500 component stocks above their 150 moving average were also extremely high (+90%), right now they are still moderate (70%). Usually, a momentum market is marked by this longer term breadth being sustained above 70% for a length of time - as it was from July 2009 to January 2010.