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The S&P 500 and the Nasdaq 100 closed at a new all-time high again. The mid-cap ETF, MDY is setting up for a potential breakout out of a long multi-week base. Small-cap stocks are also starting to wake up. And yet, there seems to be a solid dose of negative sentiment. I love skepticism during bull markets because every trend needs disbelievers.
People are citing bearish momentum divergences as the major reason. The number of S&P 500 stocks above their 200 and 50dma is decreasing while the index is making new highs. This is how indexes topped in the past. The trouble is that timing a top is a lot tougher than capturing a bottom because stocks top as individuals and bottom as a group. A bearish divergence can continue a lot longer than most expect and can resolve in two ways: We can see an expansion of the rally as more stocks participate. This happened last year in May and June. Or we can see a correction and most stocks pull back.
From where I stand, both scenarios are equally plausible right now. More stocks joining the rally mean more and better opportunities in faster-moving stocks. A correction means lower prices in the strongest companies – so many investors are dreaming about buying pullbacks in the strongest semiconductor and software stocks. Any dips will offer better risk-to-reward opportunities.
What would make me bearish is an increase in distribution days. Stocks falling on big volume for multiple days is a sign of distribution or institutional selling. We haven’t seen that yet. Stocks making lower highs and lower lows in the time frame of your interest – be it weekly, daily, or hourly is what would make me take on some short or buy put options. It’s as simple as that. Before those occurrences, bearish divergences don’t matter. They can continue a lot longer than most expect. As legendary investor, Peter Lynch said: “Far more money has been lost while preparing for a correction than during the corrections themselves”.
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