A rare signal is flashing in the market that suggests the bull rally in stocks is about to peak

The market is sending a warning to investors that the bull rally may be nearing its peak, NDR says.

The research firm pointed to deteriorating market breadth despite stocks near record highs.

The divergence is rare and has historically preceded past market tops, strategists said.

A rare pattern flashing in stocks suggests the bull market may be in the final stretch.

Analysts at Ned Davis Research pointed out that market breadth , a measure of the percentage of winning versus losing stocks in the market, is deteriorating even as major indexes hover near records.

While the S&P 500 is down less than 2% from its all-time high reached in August, fewer than 25% of stocks in the index traded above their 50-day moving averages in the last week, and fewer than 45% of stocks in the index traded above the 200-day moving average, per NDR's analysis.

It reflects the worst-ever market breadth in the S&P 500 while the index has been this close to records, Ed Clissold, the chief US strategist at NDR, and Thanh Nguyen, a senior analyst at the firm, wrote in a note.

Similar divergences between stock prices and market breadth have only been seen a handful of times throughout history. The firm screened for instances in which fewer than 35% of S&P 500 stocks were above the 50-day moving average and fewer than 50% of stocks were above the 200-day moving average , while the index itself was less than 3% away from record highs. Since 1980, there have only been six instances in which all three conditions were met, the analysts said.

Several of those instances came before bull market peaks, such as when market breadth began to diverge in September 2014 and in November 2021.

Historically, the divergence has also been a bearish near-term signal for stocks, NDR said. Once market breadth starts to deviate from the overall index performance, the S&P 500 typically sees a "downward bias" for a month and the market peaks around five months later.

"The vast majority of market tops are preceded by breadth divergences. We take technical warning signals seriously," Clissold and Nguyen wrote. "The glass-half-empty view is that mega-caps are masking trouble under the surface."

"We are giving the bulls the benefit of the doubt for now, but if the divergences do not clear on any year-end rallies, a reduction in equity exposure on expectations of a topping process would be the prudent course of action," the note added.

US stocks have remained buoyant lately, but market breadth has declined amid the sharp spike in bond yields , HSBC said. The trend attests to "severe damage under the hood" in stocks, strategists at the investment bank wrote in a note on Monday.

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