The stock market's advance since the March lows has been pretty relentless. Looking at the S&P 500 Index (SPY  ), there was one 7% dip in early June. Other than that, stocks have basically been moving higher or sideways with no other, major pullback

However, as the market advance has matured, participation is thinning. This is evident through a variety of measures like the advance-decline index, the new highs-new lows index, and the ratio of small caps to large caps. Another example is that only 6% of S&P 500 stocks are making new highs, while the S&P 500 is making new highs.

In contrast, 60% of S&P 500 stocks made new highs in late-February which was the last time that the S&P 500 made new highs. There are similar types of divergence in the Nasdaq index (QQQ  ) as well. These types of divergences typically resolve in two ways. Either, the laggards join the party or the market takes a tumble when the leading stocks encounter selling pressure.

Rotation or Selloff?

There are some good reasons to expect a decline in the coming weeks. For one, the market hasn't taken a breather since its initial liftoff from late-March. We're hitting extremes in sentiment measures like the put/call ratio and investor allocation. The market is overbought on all sorts of timeframes. Historically, these market conditions don't align with favorable returns on buying.

The thinning participation in the market's advance is also a red flag. From a bottom-up perspective, more stocks are in distribution which means that the stock market's standing is on shaky ground despite its rising prices.

What the market needs to continue moving higher is for leadership to shift away from tech stocks (XLK  ) and into the beaten-down sectors like small-caps (IJR  ), banks (XLF  ), and travel-oriented sectors (JETS  ). Last week, there were breakouts in a handful of these stocks, however, it's not certain whether those will stick. In the past, bullish price action in these stocks has been met with selling.

These stocks are more connected to the real economy which is largely dependent on the health situation improving. There have been some significant improvements in terms of coronavirus case counts dropping in the hardest-hit states like Florida, Arizona, and Georgia.

Economic data like consumer spending and travel continue to improve on a month over month basis. However, there's a considerable amount of uncertainties such as the effect of kids going back to school and colleges that could case counts to start rising again or Congress is unable to pass an extension of the stimulus deal.