It was a tough end to the week for risk assets as the major equity indexes finished lower on Friday. Before we look at the charts, it's crucial to understand the broader context influencing these movements. September has historically been a weak month for equities, a period often characterized by inflection points and heightened volatility. Today, we are reviewing three specific charts signaling potential market tops: the S&P 500 on weakening momentum, the surge in volatility, and key insights from Dow Theory.
Chart 1: S&P 500's Weakening Momentum
To kick things off, let’s take a look at the S&P 500. The index finished about 4.25% lower for the week. This decline reinforces the idea that the late-August peak was a failed attempt to reach new all-time highs. Revisiting the foundational work of Charles Dow from the early 1900s, his insights on trend following and the behavior of market peaks and valleys remain invaluable. The S&P closed below the 50-day moving average for the first time since late July. What's concerning here is the momentum picture.
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In mid-July, as we approached 5650, the RSI indicator showed momentum over 80. Fast forward to late August, and the RSI stalled around 60, indicating a bearish momentum divergence. Characteristically, for a robust bull market, we want the market to move higher on increasing momentum. However, the recent momentum signals reveal weaker conditions, not supporting a move to new highs.
Chart 2: Rise in Volatility (The VIX)
Next, let's look at volatility, a critical data point that has been particularly telling. The VIX, often dubbed the "fear gauge," finished above 38 on a closing basis, reaching an intraday peak above 65—one of the highest readings historically. A VIX below 20 generally indicates low volatility and constructive conditions. Conversely, a VIX above 20 signals elevated uncertainty and potential drawdowns in equity prices. What's perplexing is how quickly the VIX tumbled to the mid-teens soon after its spike, only to surge back above 20 this week.
This rapid fluctuation in the VIX underscores the elevated uncertainty in the market. Each day the VIX remains above 20, the likelihood of further market volatility and drawdowns increases. This volatility is a significant red flag for risk assets, making it a critical element to watch going forward.
Chart 3: New Dow Theory
Finally, we evaluate the new Dow Theory. Charles Dow's original work on indexing and market behavior remains foundational. Traditionally, Dow theory compares the Dow Industrials and Dow Transports. However, I lean towards a more modern take, comparing the equal-weighted S&P 500 with the equal-weighted Nasdaq 100. Recently, the S&P reached a new all-time high in late August, whereas the Nasdaq 100 did not achieve a new high, resulting in a bearish non-confirmation.
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This divergence suggests a market inflection point. Typically, market tops are characterized by such non-confirmations—one segment of the market breaking out while another lags. Currently, industrials, financials, healthcare, and materials are leading, whereas growth sectors like technology and communication services are lagging.
Forward Momentum
In this seasonally weak period, these charts should be front of mind for making informed decisions. For those seeking a deeper dive, my premium members at Market Misbehavior benefit from a closer look at these signals, tracking market moves in real-time. Members get actionable insights to navigate this volatile landscape.
These three charts—the S&P’s weakening momentum, the elevated VIX, and the new Dow theory divergence—are flashing warning signs. While September often brings challenges, it also offers unique opportunities for those prepared to act. For a more detailed exploration, including macro indicators like the Hindenburg Omen, check out our Premium Memberships.
RR#6,
Dave
Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.
The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.