About that Divergence in New Highs
- Posted by JC Parets
- on March 29th, 2012
Yes, this is a problem.
You see the indexes, although often discussed and traded as individual securities, are in fact are a basket of stocks. The holdings within these baskets impact the direction of the index itself. A great example of this is the effect that America’s favorite stock $AAPL has on the major averages. There are estimates that if $AAPL was part of the Dow 30, we would be approaching historic highs for the index. But it’s not. The Nasdaq100, however, has plenty of Apple stock. More than it knows what to do with actually, so the weighting keeps getting readjusted. And sure enough, the Nasdaq100 ($QQQ) is sitting at decade highs, over 25% above its 2007 peak. The Appleless Dow Industrials are no where near their ’07 highs.
The point is that the components of these averages take them higher or drag them lower. The less and less stocks making new highs, the more vulnerable the average. When new highs are made in the S&P500, you want to see an increased number of components making new highs as well. When you see less, the internals are weakening.
We saw this phenomenon in 2007. I remember joking around with Josh Brown at the time saying that if you weren’t trading $AAPL, $RIMM, $AMZN, $GOOG or the Ag names, don’t even bother coming to work. The reason was because those were the only stocks still heading higher. The banks had already rolled over and it was clear that less and less stocks were making fresh highs. Sure enough, the top of the market was near and stocks eventually got decimated.
The opposite was also true in the Fall of 2008/Spring 2009. As some of the averages were making lower lows in early 2009, there were less and less stocks making new lows. Not only was this a sign that the bottom was near, but those components that held their Fall lows and made higher lows in the Spring wound up being the leaders off the bottom.
According to Ari Wald, Technical Analyst at Brown Brother Harriman, we have a similar divergence on our hands today:
“The number of S&P 500 companies setting new 52-week high has shrunk as the rally has advanced. On Feb. 3, the net new 52-week highs — that is, the number of New York Stock Exchange companies at 52-week highs minus the ones at 52-week lows — peaked at 280 companies. At that time, the S&P 500 was at 1345.
By March 13, though, despite the S&P 500 tacking on another 50 points to trade roughly at the level we’re at today, there were just 170 net new highs, Mr. Wald points out. And as of today, there are 63 stocks at a 52-week high, and 25 at a 52-week low, for a net of 38.
“This is a bearish sign of selectivity that tends to occur when strength by big-cap stocks masks weakness in the broader market,” he warns, adding that this sort of behavior is typical of “a tired trend, and becomes worrisome when it persists through longer periods.”
The answer is YES. This is something to be concerned about.
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J.C. Parets is the Founder & President of Eagle Bay Capital, LLC. He earned the Chartered Market Technician designation (CMT) and is a member of the Market Technicians Association. More
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