I just finished writing a free post for All Star Charts India following up on where we've been over the past two months and what this past week of price action means for Indian stocks in the near term. As I was writing up the post, I noticed a lot of similarities between U.S. stocks today and where India was just a few weeks ago.
I'm going to summarize the key points, but I'd encourage you to read that post in full so you can really see what I'm talking about below. Anyway, let's just jump into it.
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 it hadn't been confirmed since prices were still above support at 11,555.
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:
- Momentum divergences across most of the major indexes and sectors
- Small- and mid-cap underperformance signaling risk aversion
- Fewer stocks in all of the major indexes hitting 52-week highs
- Fewer stocks in all of the major indexes getting overbought
Small and mid caps were hit hardest, closing at nearly four-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 U.S. stock market? Well, here's the Dow 30 (the U.S. 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 past year, particularly over the past two months.
Then, looking at a more broad measure of the U.S. stock market, we see the recent highs posted by the Russell 3000 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 U.S.
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 that this is a time to be patient and focus on hitting singles and doubles, not home runs.
Thanks for reading, and let us know if you have any questions!