Will These Divergences Matter?

Here's a chart of the Nifty 50 on April 10, consolidating tightly below all-time highs. At the index level, the bearish momentum divergence was a concern, but hadn't been confirmed since prices were still above support at 11,555.

Click on chart to enlarge view.

What isn't seen on this chart is the deterioration in the market's internals happening at the same time.

Here's a quick summary of what we were seeing.

1. Momentum divergences across most of the major indexes and sectors
2. Small and Mid-Cap underperformance signaling risk aversion
3. Fewer stocks in all of the major indexes hitting 52-week highs
4. Fewer stocks in all of the major indexes getting overbought

That brings us to today, two weeks later, when prices finally put in a failed breakout (via an Island Reversal) and confirmed the caution signals we were seeing build over the last month.

Small and Mid-Caps were hit hardest, closing at nearly 4-week lows. The point is that despite our bullish intermediate-term outlook, we cannot be aggressively long stocks in the near-term if prices in the Nifty 50 are below their 2018 highs.

The risk has shifted to the downside and we have to respect that.

So what does this have to do with the US Stock Market? Well, here's the Dow 30 (the US equivalent of the Nifty 50) sporting a similar bearish divergence as prices test their January 2018 highs.

We're also seeing some serious underperformance from Small and Micro-Caps over the last year, particularly over the last two months.

Then looking at a more broad measure of the US Stock Market, we see the Russell 3000's recent highs not being confirmed by the number of new 52-week highs among its components.

Nor are we seeing the number of its components getting overbought confirming price.

Without the catalyst of price confirmation, these divergences are not yet actionable. They can work themselves out through time or price, but until they do, our thesis for continued short-term sideways chop before an upside resolution in the major indexes remains. It took a month for them to begin unwinding in India...who knows how long it will take in the US.

In the meantime, we're focusing on individual sector/stock ideas where our risk is very well-defined and reward/risk is higher than at the index level.

Depending on the market environment, there are times where we want to swing for the fences and there are others where we want to sit back and take some pitches. Given the mixed signals we’re seeing in the short-term, we would argue this is a time to be patient and focus on hitting singles and doubles, not homeruns.

If you enjoyed this and want access to all our premium content, start you 30-day risk-free trial or sign up for our "Free Chart of the Week" to receive more free research like this.

Thanks for reading and let us know if you have any questions!

Allstarcharts Team