A Warning Sign Amid the Bullish Signals

The worst is likely behind us for stocks. And there are plenty of reasons to be bullish.

I've highlighted them in DailyWealth in recent months. But nothing guarantees a straight shot up from here.

The market can still surprise us to the downside. So we need to be prudent as investors. That means watching how prices are moving... and keeping an eye on the underlying health of the market.

Unfortunately, its health has taken a step backward in recent weeks. We just got a warning sign. And it's a reason to at least be cautious from here.

Let me explain...

Doctors don't always check on a patient just by looking them over. They often need to do some detective work if they suspect a deeper problem.

That might mean ordering a blood test or an X-ray... and taking a look beneath the surface to see if a patient is healthy or not.

It's important to do the same in financial markets. Stock prices alone can tell you a lot about the health of the market. If they're going up, things are probably good... But underlying problems are always possible. So it's often worth digging a little deeper to see what's really going on.

One way to do that is to look at how many stocks are moving higher. In a healthy market, you want to see lots of stocks rallying. That means everyone is doing well – not just a handful of the largest companies.

This idea is known as market breadth. And a simple way to track it is through the advance/decline line...

This indicator comes from adding up how many stocks were up on a given day and subtracting how many were down. You'd also add that number to yesterday's total... And then you'd do the same thing the next day. So it's a cumulative measure.

The advance/decline line usually rises and falls with the overall market. Here's what it has done in recent years...

The advance/decline line rose consistently during 2020 and 2021 as stocks moved higher. Then it fell with the market in 2022. It has also recovered alongside the stock market in recent months.

But if stocks hit a new high and this measure fails to do the same, that's bearish divergence. And it's a warning that prices could soon drop.

This move is one sign of weakness in the market. And it just happened recently. Take a look...

Both the S&P 500 Index and the advance/decline line hit multimonth highs in early February. The market broke above those levels recently. But the advance/decline line has moved much lower since.

Fewer stocks are moving higher. And that's a sign that our "patient" is less healthy than we'd like to see.

Keep in mind, though... this divergence doesn't guarantee a dramatic fall in prices. The indicator's move lower means the market isn't as healthy as we'd prefer in the near term. And we likely won't see a major rally until that improves.

It's more of a reason to expect a slowdown than an outright crash.

We have plenty of reasons to be bullish today. But we shouldn't be blind to risks along the way. Stocks just flashed a warning sign. And that means the rally is likely due for a pause.

Good investing,

Brett Eversole

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