Before I get started with the charts I want to look at today let me start off by saying I’m not ’2008 crash’ bearish right now. I think every time period is unique and there was a lot more damage done during the financial crisis compared to the current state of the economy. However, there are some similarities I want to show comparing the current equity rally and the 2007 peak. Last week I wrote that once all the taper-talk was behind us that things appears to be setting up for some weakness. It appears we are seeing that weakness now as the S&P 500 ($SPX) is off almost 30 points since then. So how does this impact the larger picture?
First lets look at the equity peak in 2007 to get some historical context before looking at the current price action. Below is a weekly chart of the S&P 500 along with the Relative Strength Index and the percentage of S&P 500 stocks above their 200-day moving average. Lets start with momentum (RSI indicator). In late 2007 we had a break above 70 into ‘overbought’ status as buyers kept prices rising.
The S&P kept marching higher as it put in higher highs and higher lows. However the RSI indicator began to diverge as it weakened during most of 2007. At the May ’07 high we saw the Relative Strength Index just barely break over 70 but still lower than it was in February. From there price fell and found support at the 50-week moving average before attempting to make a new high in October. Notice that the high was made intra-week, creating a large wick to the weekly candle. Momentum continued to go lower, putting in another lower high and a lower low.
The third panel shows the percentage of S&P 500 stocks above their 200-day moving average. This indicator of market breadth began weakening fairly significantly in mid-2007 as it put in its high in February. This divergence became severe as the S&P put in its final high in October with just 60% of stocks above their 200-MA. Going forward we all know what happened as price broke through its 50-week MA and eventually entered a historic bear market.
I’m sure you can see where I’m going with this. I won’t go into the same level of detail as I did with the 2007 example but lets touch on a few points…. We had our ‘overbought’ status achieved on the RSI followed by a very small break as the S&P put in a higher high. This was followed by an intra-week new high last week but with a continued divergence in momentum as RSI couldn’t even get above 65. I find it very interesting that the peak in 2007 was up against the rising trend line from the prior highs, just like we’ve seen (so far) this year. While the percentage of stocks above their 200-MA has diverged from equity price action, it’s nowhere near as severe as it was in 2007. We still have over 80% of stocks above their 200-MA which is still bullish on its own.
Pair this example with the historic inflows into equities last week along with the potential catalyst of the debt ceiling fiasco and the Fed tweaking its balance sheet in the coming months. We also have the seasonality that Chris Kimble recently discussed on StockTwits of past major market turning points occurring around the start of the fall (September 21st) as well as high levels of margin debt at the NYSE.
Let me finish with this….I’m not calling for a repeat of 2007/2008. In 2007 we saw a very different yield curve formation and more signs of risk taking than we do now. As I said in a recent interview with Kitco News, I think we could still see higher prices going into the end of the year as hedge funds chase performance, but what’s setting up in the equity market right now doesn’t look great. We’ll see if 2013 continues to track the 2007 price action. I think one big tell is if we continue to see the percentage of stocks above their 200-moving average continue to slide. Time shall tell. I’ll of course keep you updated with what I’m seeing as all this plays out. Stay tuned.
UPDATE 9/24/13: Looks like either I’m not alone in my thinking or Bank of America Merrill Lynch analysts read my blog: Two ‘Triple Bearish Divergences’ Are Simultaneously Hitting The Stock Market Right Now (Business Insider)
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+, Twitter, and StockTwits.