Breadth Thrusts & Bread Crusts: Market Environments: Participation > Labels

JC Parets
April 14, 2022

From the desk of Willie Delwiche.

It’s easy to fixate on percentages when discussing and labeling market moves, especially when those moves are to the downside. 

The S&P 500 can be 9.99% below its peak and you’ll hear nothing but crickets. Cross the 10% threshold and it’s a Correction. Cross the 20% threshold and banner headlines announce a Bear Market.

There are plenty of problems with this approach. A market environment where the S&P 500 is down 9.9% from its peak is likely not materially different from one where the index is down 10.1%. The same can be said on either side of the bear market threshold. Problems go beyond these arbitrary, specific thresholds. 

The questions it raises reflect its lack of utility for everyone except headline writers: Is a market that is on its way to, but has not yet achieved a 20% peak to trough decline, in a bear market? Or is it still a bull market? And what happens after it enters bear market territory but nudges higher so that the peak to trough decline is now less than the 20% threshold? Is this still a bear market?

Pundits can wrestle with these questions. Historians can come in after the fact and put dates on market cycles (in the same way dates are put on economic cycles) after peaks and troughs are clearly established. Yet when trying to identify and operate within a market environment in real time, we don’t have those luxuries.

So how can we proceed?

Rather than looking at thresholds, I choose to look at participation when it comes to identifying market environments. Specifically, if more stocks (across the NYSE & NASDAQ) are consistently making new 52-week highs than lows, that seems like a bull market. If we are seeing more new lows than new highs, that is bear market behavior. All of the net gains in the indexes (looking particularly at the S&P 500 and the Value Line Geometric Index) over the past 2+ decades have come when our net new high A/D line has been trending higher. In other words, when new 52-week highs have persistently outnumbered new 52-week lows, stocks have tended to move higher. 

This isn’t rocket science. It’s a reality that index-level strength will struggle to persist if more stocks are moving lower and making new lows than moving higher and making new highs.

This dynamic has been playing out in recent months. Over the past 100 trading days, new highs have outnumbered new lows just 11 times. During that period, the S&P 500 is down 5.5%. In the 100 trading days prior to that, new highs outnumbered new lows 77 times and during that period the S&P 500 was up 9.6%. This is not a historical anomaly. It’s the rule, not the exception.

From early January to late March, we experienced 57 consecutive days of more stocks making new lows than new highs. By the time the conventional questions about bear markets were being asked in late-February and early-March, we were already in the longest consecutive stretch of more lows than highs since the financial crisis (in 2008/2009).

That streak has since ended, but we are still seeing more new lows than new highs. The net new high A/D line, which has been moving lower since November, continues to fall. When we start to accumulate more new highs than lows on a consistent basis, this A/D line will turn higher and we can take a more constructive view on the market. Until then, it pays to be active and adaptive. Passive exposure right now brings more risk and less opportunity. 

In either case, we can listen to the market, lean on the data and let the evidence write the headlines.

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