Divergent Warning Signs Abound

Earning season is almost over and the market is entering into a seasonally weak period without any upcoming catalysts. Combining this with weakness in breadth and lack of leadership names points to the potential for a pullback. Market weakness is nothing new as I have mentioned for a few weeks how the US stock market is overbought and looks as if a short-term pullback is likely in the cards. Across virtually every strong sector, divergent high, rising wedges have formed. While these patterns are typically bearish and resolve to the downside, there are no guarantees since only 69% actually play out. This means sticking my neck out on the line on this warning of a potential s/t correction gives me a 31% chance of it getting chopped off. I’d love to have better odds but hey, it is only a warning.

A good example is that of the financial sector ETF, XLF, the big sector winner since the “Trump bump” rally. You can see in the chart below, a textbook 5-point rising wedge formed with the 4th point forming a divergent high. Since that high, price has consolidated sideways but with a downward bias and more importantly sits right on an essential support line. If the market wants to correct as the chart is warning, a break below current support provides a target below at the T1 level.  Since corrections can typically be quick, strong moves, if T1 fails to hold then the T2 area is where I would expect any downside to terminate.

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Those not long financials and have sideline cash awaiting a pullback to enter, may find this potential near-term correction a compelling buying opportunity.  If we don’t see a correction, chalk it up to the underlying strength and conviction of the bulls as they are clearly in charge.