The Charts That Could End The Rally

Each night as I go through my chart deck there are a set of charts that keep drawing my attention. These are setups involving divergences in breadth and risky assets that pose risks to dismantling the rally we’ve enjoyed since the end of last year. I’ve been fairly vocal for my distrust of this rally but have allowed price to dictate my opinion. However, these price charts are what are beginning to change my stance on U.S. equities.

So let’s get into it….

First up we have the Summation Index. This is a simple indicator that adds up the McClellan Oscillator readings, which looks at the net advancing issues. A divergence of this indicator warns us that a rally is being led by fewer and fewer advancing stocks, meaning breadth is narrowing.

On the bottom panel of the chart below we have the ratio between the high beta ETF ($SPHB) and the low beta ETF ($SPLB). This relationship can give us an idea of the health of the ‘risk on’ trade. When high beta stocks are outperforming their low beta counterparts we can have stronger trust in the continuation of an equity advance. But when the line begins to drop (as it has been for the last month) then we can see traders shifting into lower beta names as they potentially seek protection while still maintaining an equity allocation. As the chart shows, when both of these instruments have diverged from price, a correction has followed.

Next up we have the Relative Strength Index (RSI) of the relationship between stocks ($SPY) and bonds ($TLT). While equities in general (based on the S&P 500) have been hitting new highs, the momentum of $SPY:$TLT has been waning – putting in lower highs. Which leads us to believe there is some deterioration taking place in the outperformance of equities against fixed income. Like the previous chart showed, this type of divergence has not fared well for a continuation of equity appreciation.

The last chart I want to show comes from the Short Side of Long, one of my favorite blogs. Tiho posted some great sentiment charts he put together from the latest Merrill Lynch Fund Manager Survey. The chart below shows the equity weighting of fund managers hitting a high that has only been seen twice in the last seven years (2010 and 2007). It appears global fund managers have nearly all positioned themselves on one side of the stock market’s teeter-totter, leaving practically no one to push their side higher.

So these are some of the charts that are concerning me in regards to equity risk. I also tweeted out a chart of the falling percentage of stocks above their 50-day moving average, another bad sign for stocks. I’m not here to top tick the equity market or persuade you from having an equity allocation, but these setups don’t bode well for stocks, and we’ll see if Mr. Market decides to give them any credence.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+.