Important: Negative Divergences quietly piling up in stock market

Here is the list of negative divergences I have observed recently:

1) More and more amateurs have been betting on a lower U.S. dollar and higher gold prices in recent weeks, especially following the media hype about gold's new all-time high, the U.S. dollar index has barely budged over the past month. Every time DXY goes below 75 you get a headline about it on DrudgeReport, and yet for almost a month, this has been a firm bottom, the failure to move lower despite all of the hype, media fanfare, and anticipation from mainstream dollar bears, is an important signal. DXY frequently falls below 75 in the morning as amateurs eagerly sell short the greenback; by the end of the day or the following day at the latest, it regains the 75 level as important buyers repeatedly step in. Since the financial markets love to move in the direction of least resistance, any repeated failed attempt in one direction will almost always lead to an attempt in the opposite direction.

2) From October 24, 2008 through September 4, 2009, gold mining shares substantially outperformed the price of gold bullion. Since then, gold mining shares have struggled while gold bullion has continued to make new all time highs. This is one of the best-established negative divergences in the financial markets, and is almost surely sending an important message. If gold mining shares are unable to respond positively to a new all-time high for the price of gold, then a sharp surge in the U.S. dollar index is just around the corner. This would explain why some of the world's wealthiest investors have been turning to the safe haven of U.S. Treasuries, as is evidenced by the bounce in TLT from its recent important bottom of 92.45 on November 12, 2009 (last Thursday).

3) TLT (U.S. Treasuries fund averaging 25 years to maturity), has been forming a bullish pattern of higher lows since June 11, which is more than five months ago. The normal historic pattern is that in advance of any stock-market downturn, U.S. Treasuries will move higher for a certain number of weeks in advance.

4) Fund flows show that amateurs have become increasingly eager buyers not only of gold mining shares, but to a lesser extent of general equity funds. Meanwhile, corporate insiders have recently stepped up the already accelerated pace of their selling relative to their buying, while the percentage of cash held by mutual funds has been sharply decreasing.

5) Looking at global currencies, even the mighty Australian dollar, which tends to be among the most aggressive in eagerly anticipating any wave of global economic expansion, has moved generally sideways since October 20, 2009. The Canadian dollar has been making notably lower highs, as have the New Zealand dollar, the South African rand, the Brazilian real, and many other currencies of countries which have a high ratio of commodities to people. The struggle for these currencies to make higher highs in what otherwise would appear to be a highly favorable environment is a notable negative divergence for both equities and commodities.

6) Semiconductor shares have become one of the most notable underperformers in recent months, which is significant since this sector has been a reliable leading indicator of the general equity market since the late 1960s. Today's closing price for SMH was 26.07, which is barely changed from its July 30, 2009 intraday high of 25.56. When an important leading sector has virtually no net change for 3-1/2 months, it is sending an important message.

7) The widening discrepancy between the S&P 500 and the Russell 2000 (RUT). While the S&P 500 is just below its 2009 zenith, the Russell 2000 is more than 4% below its annual high. Perhaps even more importantly, the S&P 500 has continued to form a pattern of higher highs in November, whereas the Russell 2000 peaked on September 23, 2009--nearly two months ago. If you look back to 2007, you will see that the S&P 500 completed its ultimate high on October 11, 2007, whereas the Russell 2000 touched its all-time high on July 13, 2007, just about exactly three months earlier.

8) VIX, a reliable historic measure of implied volatility, has barely changed since July 24, 2009 when it made an intraday low of 23.00. Historically, this kind of behavior for VIX usually precedes a double-digit pullback for most general global equity indices.

9) Junk bonds: This sector plummeted to a 75-year low in early December 2008. HYG is an exchange-traded fund in this sector for which yesterday's closing price exactly matched its intraday high of September 18, 2009, exactly two months ago. While HYG has only been in existence for a short period of time, a long-term chart of VWEHX shows that junk bonds tend to serve as a useful leading indicator for the general equity market. The flat performance over the past two months therefore qualifies as yet another important warning that the vast majority of the stock-market rally has already occurred.

10) The Nikkei: it turned in a double-peak on September 10, at 10,513, and then 10,544 on September 24, that day the S&P 500 closed at 1,050. Note that the Nikkei is down 10% from the highs and in the past has proven to be a decent leading indicator.

The combined weight of the above negative divergences add strong support to the thesis that we will begin a severe global equity bear market some time over the next several months (0 to 5 months most likely). This bear market will likely continue for two years, and will end with much lower lows than we saw in March 2009. The greater the number of increasingly negative divergences which develop, and the more historically dramatic their behavior, the more likely that the next equity bear market will be truly spectacular.

Interesting post. Let me ask what negative divergence is? Is it a deviation from the norm with negative implications to the equity market?

This entire rally has been due to the central banks pumping easy money into the system. If the market starts going down again, expect to see more pumping

This is one of the most dangerous posts made on fatwallet. I wish I had more time to poke holes in all of the flaws in these statements. I will pick the shortest one:

8) VIX, a reliable historic measure of implied volatility, has barely changed since July 24, 2009 when it made an intraday low of 23.00. Historically, this kind of behavior for VIX usually precedes a double-digit pullback for most general global equity indices.

First of all, you definition of VIX isn't even correct. This whole statement is an opinion backed up with no fact. Where do you possibly get this information? What is your source for this? The VIX barely changed from 2003 to 2007, it slowly trended downwards. In fact, there was no double digit pullback (do you mean percent or mathematical change) during that time period but an almost 100% increase in the market. Finally, if you looked at a graph of the VIX over the time period mentioned you would notice it has moved a lot. Just because its near the same price at two random points in time doesn't mean is has barely changed. In fact, that is part of the definition of VIX.

In conclusion, if anyone is going to make investment moves based on a 1000 word post they read on an internet message board they get what they deserve.

Negative Divergence = When two or more averages, indices or indicators fail to show confirming trends.

Never heard of "McHugh".

Vix = http://en.wikipedia.org/wiki/VIX

Implied Volatility = http://en.wikipedia.org/wiki/Implied_volatility

It is interesting to see VIX moving up 10% today... my point was just that after a steep decline, it has failed to make lower lows kind of like the US Dollar index. This is just one of many negative divergences from the last couple of months that I think are noteworthy. Taken alone, none of these would be critically important, when considered together, they are noteworthy. Do your own research and come to your own conclusions.

MarketVViz said:
3) TLT (U.S. Treasuries fund averaging 25 years to maturity), has been forming a bullish pattern of higher lows since June 11, which is more than five months ago. The normal historic pattern is that in advance of any stock-market downturn, U.S. Treasuries will move higher for a certain number of weeks in advance.

The only thing worse than a bullish pattern of higher lows is a bearish pattern of lower highs.

I don't want to be rude, but there's no fantastic discovery here. You've made a short term bear case that is slightly compelling. So make your trades and put your stops on, and let us know if you make money.

OP,

I'm intrigued. Can you please compare these observations to the conditions that existed
prior to the last 7 crashes?

Thanks in advance

PS. Does this make me an amateur because I bought some more gold this past month?

to gatzdon,
- everybody is buying gold and driving the price up. technically higher highs on higher volume is good and a buy signal. Plus there are fundamentals that support buying gold. and people that own gold are seeing a profit. AND gold is a great hedge against inflation and it's not correlated with the S&P so it's good in a diversified portfolio. Just for me personally, even if it's a great buy I wouldn't buy gold today because it went up so fast BUT I do own stocks of a gold miner (also bought a few weeks ago) that moves in step with gold so it's like I own gold

JTFH said:
Uh... these are extreme conditions that I don't think have ever been seen before. This is far from anything near standard market fair... I won't be surprised in the slightest to see the March lows taken out handily. Is that fantastic enough?

You may be right. But this is an inflection point and they are fairly common. And the market can resolve to the upside again. For the past few months there are too many dollars chasing too few equities and we see multiple expansion. The biggest dislocation, bond market calling deflation vs. stock market calling inflation, has been in effect for a significant period. And before that the bond market was saying how bad the credit situation was while equities blissfully churned slightly downward.

A bear case has been made, the bull case isn't as strong - but it's the constant battle of the markets. We're returning to profitability and the PE10 multiple is only slightly to moderately over-valued (950-1050 being fair value on historic norms).

My job has a strong relation to the fiancial markets, and I do not consider myself arrogant enough to predict the largely random gyrations of the market. Beta, three factor diversification and proper allocation for risk is where it's at. Most stats arbitrage and portable alpha strategies are the equivalent of picking up nickels in front of a steamroller.

Every time there is a big up/down swing in the market, somebody comes out and says "It is gonna turn, all the signs are pointing to it. Blah, blah, blah" Markets go up, markets go down. For every move in either direction there is always someone who "saw it coming". It is just a matter of picking the right person.

For crying out loud, we don't need a wall of text. Just follow trippleB market predictions. He called the bottom of the market with a simple two liner post. Simple, accurate, to the point

trippleB market wisdom

I personally agree with the OPs assertion that the near term doesn't look pretty.

I would also add

11) Huge VIX spikes getting larger and larger each 1st of the month with larger and larger market corrections.

I do have 2 problems with what seems to be implied by this information.
1) That commodities are going to lead the way in this potentially oncoming correction
2) That there is even a 50% chance that this will go beyond the March lows

Commoditities might not perform well in a correction scenario, but this really just points to a flight towards safety. Just because commodity prices are rising fast doesn't mean that they will crash harder than the rest of the market if my next prediction is accurate

I personally believe that this will be a short term market correction not one that comes even in the range of March lows. I am admitting that there is a 20% that chance that could happen. The only reason why I'm saying that is because of the 2nd crash after 1929 that caught a lot of people's pants down. I find very key differences this time as to why I don't think this will be fate of this next correction.

What am I doing? I'm hedged. I'm still long commodities, etc. because I think that there performance looks good for the next several years in general(looking at it long term). I don't want to be wrong about an incoming correction and have pulled out if the run up continues. So I've gotten myself some protection. I'm shorting the sector that I do think will do very badly if a correction occurs.

If I'm wrong about this being only a medium sized correction and the market does tank badly all the way down to March lows, I'm not going to do well, but I wont do as bad as many others out there. I also believe that if we make it through Q1 most of this risk we are talking about will be gone for at least a couple years.

dshibb said: TripleB's post in March was impressive. I am actually curious as to what information led him to make that prediction.

+1.... Spooky, eh?

dshibb said: TripleB's post in March was impressive. I am actually curious as to what information led him to make that prediction.

Didn't you ever question his screen name?

He's clearly the alt for Buffett/Bernanke/Branson. He's got it all covered.

TripleB only made one prediction, nobody else did on the entire forum, and it was dead on. We didn't set up a poll and ask when you think the market is going to bottom and he was the one that was right. He made an out of the blue thread once and nailed it. I'm saying that warrants some praise.

Strengthening of the dollar will come as a flight to quality, there is no other reason to associate a strengthening of the dollar. A flight to quality is temporary. Long term direction of dollar is still down. Therefor that points to a long term bullish component for commoditities.

A lot of raw material consumption in just built into the world even during bad times. Also while the US may still be the big consumer, other countries around the world are stepping up to fill a lot of that consumer roll. As there currencies appreciate against the dollar(over the long term) they will be able to afford more and the US will be able to afford less. This is the natural way the market will deal with less consumption in the US.

dshibb said: TripleB's post in March was impressive. I am actually curious as to what information led him to make that prediction. My guess is the sheer frequency of posts... At ~2 posts a day some might correlate with market events.

dshibb said: Yeah, but non of them were a prediction on the market. And it wasn't a random post in a thread, it was a new thread where he clearly wanted to go on the record for that prediction. There might have been some chance involved, but he based that pick on some key information. It was to deliberate for it to be a random guess.

dshibb, is that you or did BBB hack your account?

You have a 50/50 chance. Unless your are deep inside the Fourth Branch of Government (GS) you will be late.

dshibb said: You wish. Tell me why that thread wasn't unique in any way, and why it was just a random guess. And where those other posts/threads are of him wrongfully predicting the bottom.
Regarding TripleB's prediction of the bottom of the market and its significance, choose from the following:

* 10,000 monkeys typing on different typewriters, eventually producing all of Shakespeare's plays.

* Even a broken clock is right twice a day.

* A single correct prediction doesn't make a trend.

True story: the first time I ever played roulette, I put $5 on 23. (It was the 23rd birthday of a co-worker.) I won! Regrettably (but not unexpectedly), I was never able to repeat that success. Whatever negative things I might have said or thought about tripleB's FWF posts, he has a sense of humor, and I don't think that his post was meant to be taken seriously. Did you notice the smiley at the end?

One odd thing is that the current equities run is domestic only, in the sense that it doesn't seem (given the low dollar) that foreign cash is driving things.

In addition, there are net outflows in the mutuals/etfs:

http://www.examiner.com/x-18442-St-Louis-Investing-Examiner~y2009m11d16-Mutual-fund-flows

and the cash has gone into bonds, etc (ie: principal preservation).

It doesn't seem that trading volumes are low, historically speaking. Maybe all that market activity is just active investors churning each other's positions?

Stocks have climbed the wall of worry concerning economic recovery. Can they now climb a new wall of worry about the need for the Fed to raise interest rates, and a strengthening dollar ?