Downside Participation Expands - Here's How to Measure and the Key Levels to Watch

SPY experienced its biggest weekly decline (-2.2%) since late February and the nine-week Rate-of-Change turned negative for the first time since late October. The ETF also closed below its 10-day SMA for the first time since late January. Normally, a close or dip below the 10-week SMA signals a pullback within an uptrend and such pullbacks can provide short-term opportunities to partake in the long-term uptrend. However, medium-term breadth deteriorated significantly over the last few weeks and a corrective period could be upon us.

The next chart shows the S&P 500 in the top window and the percentage of stocks above the 50-day SMA in the lower window. The blue shading starts when %Above 50-day dips below 30%. Such dips show above average downside participation. Note that the dip in June 2019 foreshadowed a corrective period into September (four months), while the dip in late September 2020 foreshadowed a corrective period into late October (one month). On both occasions, $SPX formed triangle consolidations, which is a flat time-based correction, and the triangle breakouts ended the corrections.

SPX %Above 50-day SMA is currently at 32.67% and has yet to exceed 30%, which means the official correction signal has yet to trigger. I am, however, concerned with the rapid deterioration in this indicator as it fell from 76% to 33% here in June. Also keep in mind that SPY advanced some 30% from its late October low and a correction at this stage would be perfectly normal, and even healthy. The blue zone marks a possible target in the 3800-390 area.

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