Narrowness of participation and thinner summer volume. A dangerous formula for the period ahead or recipe for a late stage short covering fueled blow off?

The technology-heavy Nasdaq Composite ended the week 73.71% off its lows since the market began its rebound in mid- to late-2022. The more value-oriented and narrowly focused Dow Jones Industrial Average had gained less than half of that amount, 32.79%. Markets were closed Thursday in observance of the Independence Day holiday, and lighter trading volumes were recorded as the week progressed.

The second half of 2024 has started like the first, with gains for major U.S. stock market indexes. There’s concern under the surface, though, thanks to sharply higher U.S. Treasury note yields and crude oil prices marching toward two-month highs.

The holiday week brought no vacation from the thin market breadth that dominated the markets early this summer. Breadth continues to deteriorate, with only 36% of $COMP stocks trading above their respective 50-day moving averages and only 41% of SPX stocks above their 50-day moving averages. It’s a little better when you look at SPX stocks trading above their 200-day moving averages, which sits near 65%, but generally, the situation continues to stress market concentration and thus thinner divergent underlying breadth, always a warning sign to traders

Putting aside the Magnificent 7″ group of stocks, the remaining 493 companies in the S&P 500® Index—or the S&P 493—were down a collective 1% on the quarter.

This large divergence and spread within the U.S. equity market can really be chalked up to excitement around AI. Certainly a market where a handful of stocks lead index rallies to new record highs generally isn’t seen as a healthy one. Investors tend to like broader participation in the markets where many sectors and types of stocks rise together rather than indexes being pulled higher by some highly capitalized names at the very top. That was the case in 2021 before the bear market of 2022, though the past isn’t precedent.

In addition, from a technical perspective, it looks like the Relative Strength Index (RSI) for some major indexes are starting to roll over, a sign of technical softness gathering. RSI is a momentum indicator, and when it falls, it can suggest fading momentum for a rally. The RSI for the SPX had recently climbed into what’s traditionally seen as “overbought” territory above 70. The SPX RSI recently fell to 66, which matches the RSI for the $COMP. RSIs still appear healthy, well below the 80 in the Nasdaq-100® (NDX) and 75 in SPX we saw two weeks ago.

To sum it all up,  I am quite concerned and cautious at these levels, especially in light of the narrowness of participation and thinner summer volume.

Perhaps a dangerous formula for the period ahead? or a recipe for a late stage short covering fueled blow off? I believe we may soon see!