5 Technical Warning Signs For The Stock Market

Five key stock indicators collectively point to a sharp deterioration in market breadth, showing that the great bull rally in 2019 is losing momentum, according to technical analysts. These indicators are: underperformance of small caps and mid caps versus the S&P 500; a declining percentage of S&P 500 stocks registering new 52-week highs; almost half of NYSE stocks are below their 200-day moving averages; the advance/decline ratio for the NYSE is dropping; and the McClellan Summation Index, which measures market breadth, has trended downward for much of 2019, according to a detailed report in MarketWatch as outlined below.

“There are some definite warning signs in these indicators,” Mark Newton, president of technical analysis firm Newton Advisors, told MW. He recently downgraded his medium term outlook from bullish to neutral, and he anticipates a significant stock market decline in the fall. Meanwhile, Morgan Stanley is forecasting a 10% correction.

Significance For Investors

Many of the leading stock market indexes, such as the S&P 500, are capitalization-weighted, meaning that the bigger a stock is in terms of total market value, the more impact it has on the index. Thus, a recent study by S&P Dow Jones Indices found that just four big tech stocks had combined to deliver 19% of the year-to-date total return in the S&P 500 Index (SPX) through July 18, 2019.

Meanwhile, the much older Dow Jones Industrial Average (DJIA) uses a different computational methodology, but is based on the premise that a collection of just 30 large stocks can be representative of the market as a whole. As indexes such as the S&P 500 and the Dow have soared to new all-time record highs in recent weeks, a growing concern is that they may be masking a decline in market breadth. That is, the indexes can be posting hefty gains even as a large number of stocks, even a majority, may be up by considerably less, or even declining.

"Market breadth remains an ongoing concern as evidence suggests there has been a growing divergence between the recent record highs on the SPX [S&P 500 Index] and overall participation," Craig Johnson, the chief technical analyst at Piper Jaffray, wrote in a recent note to clients, as quoted by MW. He observes that fewer S&P 500 stocks reached 52-week highs while the index surged to new records in recent weeks, and this raises the odds for a deep market pullback, he warns.

Mark Newton points out that small cap and mid cap stocks are lagging the large cap S&P 500 by the widest margin in 10 years. For example, for the year ending July 24, 2019, the small cap Russell 2000 Index (RUT) is down by 6.2%, while the S&P 500 is up by 6.1%, per Yahoo Finance.

Newton also sees three other negative indicators. First, less than half the stocks listed on the NYSE are above their 200-day moving averages. Second, while the advance/decline ratio for the NYSE is near an all-time high, it has been dropping for two weeks, and "many of the recent records occurred with flat or negative breadth." Third, market breadth as measured by the McClellan Summation Index peaked in late February and fell through June. It rallied subsequently, but remains well below the February high.

Looking Ahead

Technical analysts aren't the only ones cautious on the market. Mike Wilson, chief investment officer (CIO) at Morgan Stanley, expects a 10% market correction within the next three months, per Barron's. His year-end 2019 target for the S&P 500 is 2,750, which would be a decline of 8.9% from the open on July 25. Wilson remains bearish about earnings, and believes that consensus estimates going forward remain too high by about 5% to 10%.