What The Charts (And The ‘Smart Money’) Are Saying About The Market…

There were some significant technical developments in the stock market last week.

You can see them at work in the chart of the SPDR S&P 500 ETF (NYSE: SPY) below. Prices broke below the lower trendline that has supported the rally since late April. That break coincided with a lower low. It was the first lower low since the March bottom.

Why does this matter? Well, it’s important to understand that uptrends are simply a series of higher highs and higher lows. That means when prices are rising, they move above the previous high. On the inevitable pullbacks, prices tend to remain above the previous pullback’s low.

That’s the pattern we’ve been seeing since March. Unfortunately, last week’s pullback sunk below the previous low set in April. That qualifies as a “lower low”. The reason that matters is because it breaks the streak we’ve been on — a potential indication the uptrend is over.

I’ve displayed SPY’s stochastics in the bottom panel of the chart. As noted here, stochastics is a popular indicator that measures the power of a price move. Looking at this, we can see a bearish divergence. This is a time when prices reached new highs but the indicator peaked at successively lower values. The red arrow highlights this divergence.

Stochastics also fell below the significant 50 level, marked by the dashed blue line. That is almost always an indicator of at least a short-term price dip.

The blue rectangle highlights the 50% to 61.8% retracement levels. Prices are holding within that range and tested the 50% retracement level. That’s important because it shows us that other traders are also watching these levels. Because of the bounce after the first test of the 50% level, we know that large buyers came in when the 50% retracement was reached.

Market Breadth Is Deteriorating

Another worrying sign is the behavior of market breadth. This can be seen in the Advance-Decline Line for the New York Stock Exchange. The A-D Line is found by tracking the number of stocks that close higher and lower every day. The number of stocks that declined is subtracted from the number that rose.

The difference between the number of advancing and declining stocks is shown in the chart below. When there are more advances than decliners, the line moves higher. When the number of stocks that closed down exceeds the number that closed up, the A-D Line moves lower.

Remember, this is a breadth indicator. Each stock, in effect, gets one vote. This is different than price indexes where stocks carry different weights. In the NASDAQ 100, for example, just three stocks (Microsoft, Apple and Amazon) account for more than 30% of the index. Those same three stocks represent more than 11% of the S&P 500 Index.

This means indexes can reflect price moves of just a few stocks. The A-D Line can only move up when more than half of the stocks traded that day close higher. The chart below shows the A-D Line also made a lower low, breaking the uptrend that began with the March low. Stochastics is also bearish in this chart.

With price and breadth pointing down, now is an excellent time for caution.

This Big Bank Is Building A War Chest

On the news front, we continue seeing large investors moving to the sidelines. Last week, I highlighted Warren Buffett’s decision to sell airline stocks at a loss. Buffett also increased the amount of cash he is holding, indicating he doesn’t see any bargains in the current market.

Adding to that is PNC’s decision to sell its stake in BlackRock, the world’s largest asset manager.

PNC is America’s seventh-largest commercial bank. It holds 22% of BlackRock, a stake worth about $17 billion, which it has owned for about 25 years. PNC’s CEO told the Financial Times that the decision was driven by “the bank’s increasing fears over the US.”

The sale would give him a “bulletproof” balance sheet to deal with an extreme crisis or a war chest to buy distressed assets in a more moderate recession.

“As we entered this crisis, it became clear that everything we thought we knew was proven incorrect. We’re in this economy where everybody bases their models predicting the future on the past and of course we’ve never been in a situation where [we] effectively have been forced to shut down on the economy with this much fiscal stimulus.”

“I can’t stress the importance of being able to play offence into that environment. If you’re left in a situation where you’re defending, where you’re shrinking your balance sheet, where you’re worried about your capital, where you’re continually cajoling shareholders, or clients to stick with you, you’re not focused on growing.”

PNC is not in any danger, so this isn’t a forced sale. The bank’s common equity tier one ratio is 9.4%, well above the regulatory minimum of 4.5%. The sale will increase the ratio to 11.4%. This ratio is used to ensure that banks are prepared for a financial crisis.

The Financial Times quoted an analyst with Wells Fargo, who explained why this news is important.

“Remember this is the CEO who led the takeover of National City at 40% of tangible book during the great financial crisis — an incredible deal.”

PNC is obviously expecting a similar opportunity since BlackRock accounted for about 15% of PNC’s earnings last year. The CEO said, “If we end up in a situation where the economy comes roaring back, we’re going to be left with diluted earnings and excess capital. If things are bad or mildly bad or really bad, we have an outsized opportunity to go into this with eyes wide open.”

Action To Take

PNC’s decision is the latest example of large investors taking actions that tell us a lot. To put it simply, it indicates they believe there will be a better buying opportunity than what is available today.

In other words, the smart money is preparing for another decline. And that could be the best strategy for individual investors as well.

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