Sunday, June 01, 2008

Divergences in Money Flows

One of the factors that led me to question the bear market's viability back in March was the divergence in money flows for the Dow and S&P stocks relative to January. Although we saw fresh price lows in March, higher lows in money flows suggested that selling was drying up. These divergences were confirmed by the fewer stocks making 52-week lows in March relative to January and by a host of sectors that failed to make fresh price lows in March. Money flows are thus part of a larger picture of market participation that can tell us when supply or demand is growing or waning.

In my recent post, I noted a money flow divergence within the S&P 500 energy sector (XLE). As price has moved higher, we're seeing lower peaks in money flow, suggesting that demand for the energy stocks may be drying up.

Interestingly, we're seeing a similar pattern among the materials stocks from the S&P 500 universe (XLB; top chart) and among the consumer staples issues (XLP; bottom chart). Price has been moving higher for those sectors during May, but money flows have been weakening. This tells us that, overall, upticks have been occurring on lower volume than downticks--a sign that large investors and traders are leaning to the sell side.

Taken alone, these divergences are simply yellow caution lights for the sectors. When they are occurring across a large number of stocks and sectors, they are caution lights for the broader market. It's when we see waning flows accompanied by fewer stocks making fresh price highs; divergences in the cumulative NYSE TICK; and divergences in the number of stocks closing above their long-term moving averages that it makes sense to become concerned about significant price reversals. I will be examining those latter indicators tomorrow in my indicator update post.