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Rally Continues... as well as the Build up of Negatve Technical Evidence.

|Includes: SPDR S&P 500 Trust ETF (SPY)

The rally has been powerful, long lasting, and to many, confounding. However, negative technical evidence has been building, and while we haven’t broken down yet, and there have been many false breakdowns, I hold the opinion that we cannot continue this course in the face of so much negative technical evidence without some unforeseen fundamental catalyst which I don’t believe will materialize.

Fundamentals Fail to Move Markets?

In the beginning of the month, I noted how the market got surprising bullish jobs data, but this data was unable to push the market higher. When the market fails to respond to fundamental bullish news, this is a red flag.

Momentum Divergence Early Warning

A divergence in momentum is usually one of the early warnings that a move has lost steam and is due to pause or even reverse, and we’ve now seen a sustained divergence in  momentum begin to build up in the indexes.

Chart 1: Momentum Divergence

docs.google.com/View

There is a notable disagreement between price and momentum here; we can see a new high being set following a breakout, however, RSI disagrees and failed to follow price and did not set a new high. Furthermore, RSI has also dipped below the 50% mark, into the generally negative territory.

Dow Theory

There has also been a notable divergence between two widely followed indices; the Dow industrials and the Dow Transport Index. One of the basic Dow theory tenets is that the indices should move together, and when one’s move is not confirmed by the other, a red flag is raised, signaling a possible turn around in stocks.

Chart 2: Transport Divergence

docs.google.com/View

 We can see in the chart that despite the new high set following the sideways break out, not only we  have declining momentum, but the Dow Transport Index has also failed to follow the general market.

 Follow the Volume
This rally follows a bearish pattern of volume peaking into selling, then trickling off into buying.

Chart 3: Bearish Volume Characteristics

 docs.google.com/View

This chart illustrates that despite the strong move in stocks, interest has been continually falling. Furthermore, insider selling has been very high, accompanied with secondary offerings that should continued to increase the float of the market. Lastly, inflow into equity funds may have dried up, signaling that buying interest in the stock market has peaked. Two weeks ago, equity fund inflow peaked, followed by a large decrease in inflows. Last week, there was actually outflows from equity funds, the first time in months.

 Summary:

Stocks have continued upward but are now facing a strong confluence of technical resistance. Volumes have been poor, and stocks are now running into some serious overhead resistance. I think the only thing at this point that can move stocks higher here is a very strong showing in upcoming earnings. I think there will be an improvement in earnings, however, I don’t think the improvement will be as strong and current prices are assuming.  

Disclosure: Short the SPY