Throughout the recovery from the market’s early-2018 correction, we suggested any new high would be a good candidate for a “fake-out breakout” along the lines of those occurring near the bull market tops of 1990, 2000, and 2007 (Chart). So far that speculation has been on the mark, with the S&P 500 managing to better its January 26th peak, by a mere 2% in September, before plummeting.
Conditions at those three prior bull market tops were not unlike today’s, with the economy near full employment and with our monetary and liquidity measures having deteriorated for many months.
We would have to concede, though, that the tops of 1990, 2000, and 2007 were all better “telegraphed” by the action of the market itself, than the September-2018 peak. Each of those earlier peaks was preceded by a multi-month breakdown in both leadership (Utilities, Transports, Financials) and market breadth (A/D Line, Equal Weighted S&P 500, Small Caps). Using our simple definition of a “negative divergence” (the failure of an index to make a new high during the month leading up to an S&P 500 bull market high), only Utilities and Financials had sounded alarms before the S&P 500 bull market peak on September 20th.
Nonetheless, secondary measures of market internals (like the NYSE and NASDAQ High/Low Logic Indexes) suggested all summer that the internal trend was in fact deteriorating—and so did the action in low-grade corporate bonds. The spread between BAA-rated corporates and 10-year Treasury bonds was unable to revisit its cycle “tights” when stocks went to new highs in September, and it has shot up another 50 basis points in the last two months. That compares with a mere ten basis-point increase during the stock market’s January/February decline.