The S&P 500 is in rally mode, but unlike the last few rallies there are some important cautionary indications in the charts.
The chart below plots the S&P 500 along with its 200-day average. The prices are rising and the 200-day average is clearly trending up. That's good and encouraging. However, some related charts are raising cautionary flags. The rally phase labeled "A" on the chart has confirmation from plots shown in the lower panels. The rally phase labeled "B" on the chart does not have confirmation (it has negative "divergence") from the plots shown in the lower panels.
Click to enlarge all images.
The first plot below the S&P 500 chart is the percentage of the 500 stocks that have bullish point and figure charts. In the prior phase "A" rallies, the percent was above the 70% level, but the percent for the current phase "B" rally is below 70%.
The second plot below the S&P 500 chart is the percentage of the 500 stocks that have prices above their 200-day moving average price. That percent provided confirmation of the phase "A" rallies, but diverge to provide non-confirmation for the phase "B" rally.
The third plot below is the ratio of the price of the Dow Jones Transportation index (proxy IYT) divided by the Dow Jones Industrials (proxy DIA). The conventional wisdom says that the transports (which move the products for the industrials) must go up too when the industrials (which rely on the transports) go up. The transports confirm the phase "A" rallies, but negatively diverge from the direction of this phase "B" rally.
The fourth plot below is the ratio of the price of the Russell 2000 small-cap stocks (proxy IWM) divided by the price of the S&P 100 xtralarge-cap stocks (proxy OEF). Conventional wisdom says that small-caps lead rallies. The rising ratio confirmed the phase "A" rallies and negatively diverges from this phase "B" rally.
The fifth plot below is the ratio of the price of the S&P 100 xtralarge-cap stocks divided by the price of the Russell 50 mega-cap stocks (proxy XLG). This ratio also provided confirmation for phase "A" rallies and negative divergence for this phase "B" rally.
The combination of the small-cap to xtralarge-cap ratio and the xtralarge-cap to mega-cap ratio indicated that the phase "B" rally is relying on and concentrated among fewer stocks than the phase "A" rallies. When breadth of rally participation falls, the durability of rallies declines.
Disclosure: QVM has positions in SPY as of the creation date of this article (Aug. 17, 2012).
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