Short-term Indicator Crossover. Mini Pullback in Stocks Likely.

The short-term indicator tracked (Slow Stochastics) has crossed over in overbought territory signaling a high probability of a pullback in stocks. Since the near-term indicators (Momentum and MACD) are flashing only a half warning sign at this time (see yesterday's blog posting), the odds are that the likely pullback will be modest (see accompanying chart for examples of the four prior pullbacks over the past 3 months).

Should this occur, the pullback will almost certainly be followed by another run to higher current rally highs (above Tuesday's 1115 closing high in the S&P 500). It is during this run that two factors should be watched closely:

1 - Will the near-term indicators (Momentum and MACD) BOTH fail to confirm the higher highs with higher highs of their own (thereby signifying a deceleration in the strength of the move)?
2 - Will other indices (such as EAFA (EFA) or emerging markets (EEM)) fail to confirm and not make higher highs?

If both the internal metrics of an index tracked (in this case, the Momentum and MACD of the S&P 500) AND the external metrics tracked (index to index, e.g. SPX versus EFA and/or EEM) produce divergence signals from the S&P 500, then the odds increase significantly that (a) a decline will occur subsequently and (b) it will be more substantial than the mini pullback the current rally is at risk for.