Last week, I mentioned that I’d be watching breadth and measures of market quality closely due to the fact that they were lagging the market. This week, breadth as measured by the NYSE Advance / Decline line (NYAD) has improved and cleared the divergence that had been in place. As mentioned in the post, divergences under 13 weeks are often noise… which ended up being the case this time. NYAD making new highs as the market breaks out is the type of action I like to see. My measures of market quality ticked up slightly this week, but they aren’t showing the strength I’d like to see in the intermediate term. This isn’t too concerning in the overall scheme of things, but the lack of strength could cause them to fall below zero in the next week or two if their intermediate term trend isn’t righted. This would have us raising cash or adding hedges amid a rising market if the price trend continues. Conclusion Breadth measures are confirming
Over the past week, my core market health indicators continued to bounce around with some moving up and others falling. Most notably, my core measures of risk moved above zero. This changes the core portfolio allocations as follows: Long / Short Hedged portfolio: 100% long high beta stocks Long / Cash portfolio: 100% long Volatility Hedged portfolio: 100% Long (since 11/11/2016) Another thing of note this week is that my measures of trend are now in overbought territory. This occurred as my measures of market quality fell. It’s not a situation I like to see happen. This adds some doubt to the current market, but some of the other measures I watch are simply showing normal bullish rotation. So the question is, bullish rotation or the start of a larger decline? We’ll have to wait and see. Another thing that is somewhat concerning is that measures of breadth suffered more than expected this week. Take a look at the percent of stocks in the S&P 500 Index above their 200
It’s been a while since I highlighted some breadth indicators so here we go. First is the NYSE Advance / Decline line (NYAD). All I can say is Wow! NYAD is telling us that small cap stocks were the place to be coming out of the February low. Comparing the S&P 500 Equal Weight Index (SPXEW) against the S&P 500 (SPX) shows us how big cap stocks have performed against mega cap stocks. The move out of the February low showed widespread buying of big cap stocks, while mega caps lagged. This was a rotation out of the safety trade. Then we got a bit of consolidation in SPX as investors took some profit in big caps and re-allocated it to mega caps. Now it looks like the market is getting ready to run again, fueled by big caps. The percent of SPX stocks above their 200 day moving average (SPX200) shows the same picture as SPXEW. Widespread buying of big caps, followed by some consolidation, then renewed widespread buying.
Over the past few days various measures of breadth have show quite a bit of weakness. As I noted in this post, large market declines come when breadth is already weak. With such weak readings the odds have increased that this decline will be 10% or more. Below are some breadth examples. First is NYSE Advance/Declines. They led the current decline in the S&P 500 Index (SPX). Small caps are especially sensitive to this condition. Next is the Bullish Percent Index (BPSPX). It currently has less than 60% of the stocks in SPX with bullish point and figure charts. This indicates a significant number of stocks in down trends. Last is the percent of stocks in SPX that are below their 200 day moving average. Nearly 50% of SPX stocks are below their 200 dma. With all three measures of breadth showing significant weakness, a signal from my market risk indicator should be taken seriously.
A few weeks ago Urban Carmel at The Fat Pitch wrote a post that concluded that the NYSE Advance / Decline line (NYAD) was a poor timing indicator. I generally agree with his assessment. I think that most measures of breadth by themselves are poor timing indicators. Markets can fall when breadth is healthy and breadth often diverges at market tops for a very long time before the market actually falls. For example, the Bullish Percent Index (BPSPX) and the percent of stocks below their 200 day moving average have been diverging with the S&P 500 index (SPX) for over a year (or two depending on how you count). The fact that breadth isn’t timely is why I don’t use it as a part of my “core” indicators. Instead, you’ll hear me refer to various forms of breadth as ancillary or secondary indicators that give good background information. So what information does it give? Answer: When breadth is poor the odds increase that a decline will be large. If breadth
Over the past week my core measures of risk held steady while all of the components of my market risk indicator moved closer to warning. This is a crosscurrent where we’ve got positive core strength, but increasing skittishness by market participants. When this condition occurs we usually see higher volatility until both indicators start moving the same direction again (either up or down). Currently one of the four components of market risk is warning and a second is on the edge. The other two are still a safe distance away so it will likely take a sharp decline in the market to generate a warning signal. Another sign of crosscurrents comes from my core market health indicators vs. ancillary indicators. All of the core categories rose or held steady (even though the market fell). While, measures of breadth and other ancillary indicators are deteriorating. I suspect this likely result in more volatility before the market can move higher. Here are some things I’m seeing that provide background information that increases
Over the past week the non-confirmation in Dow Theory between the industrials (DJIA) and the transports (DJTA) widened. Both indexes have been painting a line for over two months. Now both indexes have broken out of their lines. The problem is DJIA broke upward and DJTA broke down. This creates a non-confirmation that warns of a possible long term trend change in the near future (next several months…remember Dow Theory is about the very long term trend). Until this non-confirmation clears with the transports moving to new highs (and of course the industrials too) investors should be cautious about adding new long positions. On the other hand, if DJIA breaks the lower boundary of its range along with the transports then it will add a larger warning that the long term trend might be changing. Any low created after a break lower from the range in both indexes will create a new secondary low that will be the trigger point of a change from a bullish trend to a bearish
Here are a couple more things showing up that are small warning signs. First is the ratio between the S&P 500 Equal Weight Index (SPXEW) and the S&P 500 (SPX). It is close to breaking below its 20 week moving average. The S&P 500 index is weighted by market capitalization so the larger stocks have more influence on its movement. SPXEW is weighted equally so a ratio between SPXEW and SPX will show money moving between large cap and mega cap stocks (because SPX is made up of large and mega caps). When the ratio moves down it indicates money moving into mega caps. Possibly from a flight to safety, but is most likely market participants buying companies with global exposure in reaction to recent dollar weakness. A move below the 20 week moving average often results in a choppy market for a few weeks due to the rotation. Another thing that is a bit concerning is the NYSE Advance / Decline line (NYAD). Since the lows in October NYAD
Over the past six months there has been distribution occurring in the market. However, the market has been able to move higher due to bottom fishing and value buying. So far the choppy market we’ve seen since the first of the year has been a result of profit taking (distribution) in stocks that had been making new highs with the money raised being put to work (accumulation) in stocks that have been beaten down enough that they were making new lows at the end of last year. When the S&P 500 index (SPX) broke higher in March the number of new highs jumped to healthy levels. Currently, SPX is within 2% of those highs, but NYSE new highs aren’t rising rapidly. This is a bit of a concern and suggests that distribution is still occurring, but nothing to worry about yet. Another sign of the battle between the accumulators and distributors comes from Trade Followers breadth. It is holding up at healthy levels with the same condition as NYSE new
As long time readers know, I usually focus on intermediate term indicators because our core portfolios attempt to catch intermediate term up trends (and avoid large draw downs). I don’t often focus on long term indicators so I thought it would be good to step back a bit and see what the very long term indicators are telling us. For the most part they are still showing healthy readings that indicate a long term bull market, but they’re starting to stall. Over the past month the monthly MACD for the S&P 500 Index (SPX) has be crossing back and forth between a bullish and bearish cross. Momentum for SPX is diverging from price as well. As you can see from the chart below, these two indicators have been losing strength for well over a year. For that reason, they aren’t very timely so instead of using them to indicate portfolio allocation changes I use them as warning to watch intermediate term indicators more closely. Looking at SPX on a weekly