Fewer S&P 500 Stocks Join Rally, Hinting at Potential Market Trouble
The S&P 500 and Nasdaq Composite ended Friday just shy of record highs set earlier this week. However, fewer stocks have been climbing alongside them.
This could spell trouble for the broader market, according to Tom McClellan, technical analyst and editor of the McClellan Market Report.
In a report on Friday, McClellan noted that the New York Stock Exchange’s advance-decline line has been declining since hitting a near-term peak in early May, even as the S&P 500 continues to rise.
McClellan expressed concern over this divergence between the S&P 500 index (SPX) and the number of stocks participating in the rally, as it has historically preceded pullbacks in the index.
“Most of the time, the NYSE’s A-D Line will echo what prices are doing. That is the normal behavior. But I watch the NYSE’s A-D Line carefully all the time, because historically a bearish divergence like what we are seeing now has been a big sign of trouble,” McClellan said in the report.
Although major indexes like the S&P 500 have been growing more concentrated for some time, flagging breadth can still signal trouble.
As McClellan explains, when liquidity — the supply of money available to invest — starts to dry up, it typically impacts smaller stocks first, before affecting larger peers. Signs of waning liquidity helped him anticipate a selloff in stocks in April.
Fewer members of the tech-heavy Nasdaq-100 have been climbing lately, which could also indicate trouble ahead. According to McClellan, the divergence between the Nasdaq-100 and its advance-decline line is even more alarming than that of the S&P 500 and the NYSE.
He noted that this was only the fifth time the Nasdaq-100 (NDX) has seen such a bearish divergence since 1993.
“Most of the time it just does what the NDX does. The other times were in 2021, shown in the chart, plus back in 2000, 2007, and again in 2015. All were good indications of trouble coming,” McClellan said.
The S&P 500 hit its 25th record close of 2024 on Wednesday, before a modest pullback on Thursday and Friday left the index higher for the week.
Similarly, the Nasdaq Composite (COMP) reached its 13th record close of 2024 on Wednesday. It also finished higher for the week despite modest declines on Thursday and Friday.
McClellan cautioned that deteriorating market breadth isn’t a surefire signal of an imminent pullback. It could just as easily recover in the coming days and weeks. Rather, it might indicate that the liquidity backdrop propelling the S&P 500 and Nasdaq Composite to record highs could be weakening.
Some investors have grown increasingly nervous about signs of weakening market breadth, particularly after three stocks reached a near-unprecedented level of dominance in the S&P 500 earlier this week.