Let us suppose that instead of Thursday’s 2% broad market rally we had a down 50 point day on the S&P 500, thus likely negating the bullish divergence in the Russell 2000 that I had discussed several times. If that happened, the correct strategy for me would have been to lighten up long exposure and reevaluate the entire bull thesis, rather than making a suicide pact with the divergence and my portfolio.l
Now let’s flip the script and focus on the divergences that bears, in particular, have been observing. Both the transportation stocks and semiconductors seemed to have been pointing to a bloody September for the market before Thursday. And yet, both sectors ended up printing huge bullish marubozu daily chart candles right where they needed to.
As I had noted before, the semiconductors had broken out from their summer channel (second chart below of the daily SMH ETF), only to see a grinding “throwback” or retrace to the breakout point. In fact, the semis pierced back down through the breakout point, adding fuel to the bears’ burning desire to short this market into oblivion. Of course, you will notice that the now-rising 50 day moving average on the SMH held firmly as newfound support, despite the dire nature of the pullback. Beyond that, note the orderly falling wedge pattern (light blue lines) the semis had settled into, followed by Thursday’s strong breakout higher. With a rising 50 day moving average and price now above the summer breakout point, the presumption is still that the bulls are in control, even of the dreaded semis. You could certainly argue that the semis represented a classic bear trap or shakeout.
Turning to the trannies, the first chart below of the Dow Jones Transportation Average indicates a strong marubozu daily chart candle right where it needed to occur at major support, similar to the semis. Moreover, if you look at a chart of CP, you would see Wednesday’s hammer after a pullback was confirmed to the upside by Thursday’s strong rally. Also, the lagging FDX confirmed Wednesday’s high volume inverted hammer with a marubozu in its own right.
These technical developments do not necessarily mean that the semis and trannies will suddenly lead this market higher, nor that CP and FDX are ideal setups (there are better ones out there) However, it does throw a huge wrench in two of the bears’ best arguments here. Even if both groups continue to lag the leading indices and sectors, that fact did not offer much of a consolation to amateur shorts who got squeezed badly on Thursday.
As I have been noting for a while now, the daily work that should have been put in to analyze a plethora of improving individual charts in this market was likely to trump any cherry-picked indicator, hunch, inside information, macro arguments, or politically-charged discourse when it came down to being positioned properly in this market. Eventually, common sense dictates that the trannies and semus ought to play catch-up to the bull if this rally has legs.
However, as long as days like Thursday occur, unless you are loaded with trannies and semis in your portfolio there is not much of a short-term case for trading based off of their action. Indeed, divergences can remain intact longer than you can remain solvent.