Stock Market Warning Signs: Why I’m Getting Defensive

The major indexes have been holding near their highs, but underneath the surface, the market has been telling a very different story. Now price itself is beginning to confirm some of those warnings.

In this October 14 market update, I walk through what I’m seeing across the S&P 500, Nasdaq, Russell 2000, market breadth, credit, Treasury yields, the dollar, and the leading growth stocks.

For weeks, the biggest reason I remained constructive was simple: price was still holding up.

Breadth was weak, new lows were expanding, credit conditions were becoming less supportive, rates were moving higher, and leadership was narrowing, but the major indexes were still near their highs, and the market appeared to be tightening in a constructive pattern.

Now that picture is beginning to change.

The Price Action Is Starting to Confirm the Warnings

The attempted breakout has failed back into the range, major indexes are testing or breaking important moving averages, distribution is increasing, and many of the stocks and industry groups that had been leading the market are failing to follow through.

That last point is especially important.

William O’Neil taught that a healthy market advance should be confirmed by strong leadership. When the indexes appear healthy but quality stocks stop breaking out and following through, the message can be very different from what the averages are showing.

Former leading technology groups are weakening. Breakouts are failing. Stocks are moving to new highs and quickly falling back into their bases. At the same time, defensive groups are moving toward the top of the relative strength rankings.

O’Neil also placed tremendous importance on distribution days. A cluster of distribution can be a warning that institutional selling is taking place even while the averages still appear relatively healthy.

That does not automatically mean you go aggressively bearish. It means you should start thinking more seriously about raising cash, reevaluating exposure, and protecting capital.

What Martin Zweig Would Be Watching

Martin Zweig approached the market from a somewhat different angle.

Zweig focused heavily on monetary conditions and market momentum. Rising interest rates generally work against stocks, while falling rates tend to provide a more favorable backdrop.

But monetary conditions alone were never enough. The tape had to confirm the message.

For much of this period, that confirmation was missing because the major indexes continued to hold up. Now the tape is weakening too.

That does not mean a bear market is guaranteed, and it does not mean the market cannot reverse tomorrow. It means the weight of the evidence has changed.

When risk rises, Zweig’s philosophy was to reduce exposure rather than stubbornly fight the market. Become more aggressive when conditions improve and more conservative as risk increases.

Protect Capital First

This is a protect-your-capital market, not a press-the-gas market.

If your stocks are working, there is no reason to panic. But this is probably not the environment to force trades, increase position sizes, or give weak stocks lots of room.

Instead, I want to see the market prove itself with follow through from strong stocks, in strong groups.

The market does not have to become a bear market for the correct response to be more defensive.

We are not predicting a crash. We are responding to a deterioration in probabilities.

Until the evidence improves, I would rather protect capital and wait.

There will always be another opportunity.

Watch the full video for all of the charts and signals I’m tracking right now.