Back in February this year my technical take on the market was featured on an “Off the Charts” segment of Mad Money. I noted that there was an interesting bearish divergence going on between the S&P 500 Index and the S&P 500 Equal Weighted Index. The familiar S&P 500 Index is dominated by five major tech stocks which account for about 20% of its weighting. The S&P 500 Equal Weighted Index gives equal weighting to all of the stocks in the index. Consequently, a rally in tech stocks can distort the balance between these two indices even though they are both comprised of the same stocks.
At the time we noted: the S&P Index was breaking above the resistance line of a horizontal channel pattern, while the equal-weighted Index was not. We suggested this was a bearish divergence. That the two indices would have to realign at some point. The higher probability scenario was that the technology stocks were distorting the performance of the S&P 500 index. This would mean that the breakout on the S&P 500 chart was a false breakout and that it would have to revert back in the direction of the equal-weighted chart.
This week the S&P 500 Equal Weighted Index has dropped about 5% while the S&P 500 Index has only dropped about 1.5%. This is action reminiscent of the February bearish divergence. It suggests the S&P 500 Index will have to realign with the S&P 500 Equal Weighted Index. This does not necessarily suggest a pullback of the magnitude we saw in March but be alert. Preserving capital is the prime objective in trading.