By José Adinolfi
Fewer S&P 500 Stocks Part of Rally, Which Could Mean Trouble
The S&P 500 and Nasdaq Composite finished Friday just shy of all-time highs reached earlier this week. But fewer stocks have been rising along with them.
That could spell trouble for the broader market, according to technical analyst Tom McClellan, editor of the McClellan Market Report.
McClellan noted in a report on Friday that the NYSE's advance-decline line has been sinking since hitting a short-term peak in early May, even as the S&P 500 has continued to rise.
This divergence between the trajectory of the S&P 500's SPX index and the number of stocks participating in the rally is concerning, according to McClellan, because it has historically precipitated a decline in the index.
"Most of the time, the NYSE AD Line will echo what prices are doing. That's normal behavior. But I watch the NYSE AD Line closely all the time, because historically a bearish divergence like the one we're seeing now has been a big sign of trouble," McClellan said in a Friday report.
Although major indices like the S&P 500 have become more concentrated for some time, signs of weakened breadth can still indicate trouble.
As McClellan explains, when liquidity - that is, the supply of money available to invest - begins to dry up, it typically affects smaller stocks first, before affecting their larger peers. McClellan explained in March that signs of waning liquidity helped him anticipate a stock sell-off in April.
See: Why this stock market timer turned bearish, falling through mid-April
Fewer members of the tech-heavy Nasdaq-100 have been rising lately, which could also portend trouble ahead. According to McClellan, in some ways, the divergence between the Nasdaq-100 and its advance-decline line is even more alarming than that between the S&P 500 and the NYSE.
"This is a pretty rare event, because it almost never shows a bearish divergence," McClellan said.
He added that this was only the fifth time the Nasdaq-100 NDX had experienced a bearish divergence since 1993.
"Most of the time it just does what the NDX does. The other times were in 2021, as shown on the chart, plus 2000, 2007, and again in 2015. All were good signs that trouble was coming."
The S&P 500 hit its 25th record close of 2024 on Wednesday, before experiencing a modest pullback on Thursday and Friday that still left the index higher for the week.
Similarly, the Nasdaq Composite COMP on Wednesday hit its 13th record close of 2024. It also finished the week higher despite modest declines on Thursday and Friday.
McClellan cautioned that deteriorating market breadth is not a sure sign that a pullback is coming. It could just as easily recover in the coming days and weeks. Rather, he could indicate that the liquidity environment that has helped propel the S&P 500 and Nasdaq Composite to record levels could be weakening.
Some investors have become increasingly nervous about signs of weakening market breadth, particularly after three stocks reached a near-record level of dominance of the S&P 500 earlier this week.
See: Three stocks now account for 20% of the value of the S&P 500. That's making some investors nervous.
-Jose Adinolfi
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06-07-24 1829ET
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