HAUKE: Negative divergences hint at adjustment

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Today we have a world of big and small. Strange things to some, but to us it takes on the feel of a comfortable glove.

When Ben Bernanke and Henry Paulson plunged capitalism further down the rabbit hole in 2008, we had no choice but to follow. We have now emerged (although most of the world is still stuck, staring at the potions) and we see with a little clarity that maybe, just maybe, the old gang is back together again.

I believe in the herd, and I rely on human nature to remain more or less consistent through time. When it comes to investing, the herd is wrong at the extremes, but until it reaches maximum density, it can be right for long periods of time.

It is early December and we are currently sitting with a stock market that is up significantly from the March low, but down tremendously from its all-time high. There are believers in this market, but there is still a thick crowd of doubters. The doubters look at the ridiculous pile of printed and borrowed money around the globe and rightly think that someday there is going to be hell to pay for that. They are incorrect in thinking that the hell is coming next week. And, as the market grinds higher, there a few more of those bears who quietly slip over to the bull side.

Since the middle of October, this tug-of-war has produced a big list of what we call negative divergences within the stock market. One example of a negative divergence is when the Standard & Poor’s 500 index hits a new high and the advance-decline line does not. Divergences similar to what we are seeing today began showing up in the stock market in June 2007, causing me to write in August 2007 that the seeds of the next bear market have been planted.

Other notable divergences since the middle of October are numerous. Throw in the fact that the percentage of stocks above almost any moving average did not follow the mid-November move and, as I said, we have a big list.

This big list is countered by something critical, however, and that is time. It’s been only six weeks, which is a small amount of time in the diverging/confirming indicator world. In the last bull market, ice cracks first appeared in June 2007 but it wasn’t until October when the danger significantly elevated. These divergences typically need four to five months to do enough damage to destroy an up move. Vigorous historical testing strongly demonstrates that six weeks is simply not enough time.

That doesn’t mean everything we have seen since the middle of October should be laughed off and forgotten. The fact is that we have a stock market moving higher with less participation. The enthusiasm is waning, clearly demonstrating that fewer and fewer investors are willing to chase prices higher.

At some point, and it could be at any time, there will be an adjustment for these negative divergences. But until more time elapses, the greatest risk right now seems to be shorter term in nature. A 5-percent, maybe even a 10-percert correction could start today.

But the evidence shows that the uptrend should remain in place for another few months at least. And there is still the very real possibility that these divergences will disappear during the next rally phase, which in essence resets the clock on the life expectancy of this upside move.

For now, this big list is worth watching. Any near-term downside resolution, though, should be looked at as a buying opportunity, even if it is to grab the last piece of the rally.•

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Hauke is the CEO of Samex Capital Advisors, a locally based money manager. His column appears every other week. Views expressed here are the writer’s. Hauke can be reached at 203-3365 or at keenan@samexcapital.com.

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