From the desk of Steve Strazza @Sstrazza
We are constantly analyzing market breadth. We do this not just for insight into the strength of the current trend but also because it helps us identify key turning points. We outlined a variety of deteriorating breadth measures in a post last month to support our bearish outlook on stocks, and the signal turned out to be quite timely as the market collapsed soon after.
With the market now severely oversold amid one of the swiftest bear markets in history, we’re looking to breadth measures once again for signs of a tradeable low.
Last month, we were looking for signs of a top so were observing breadth indicators such as the percentage of stocks making new highs and registering overbought momentum readings and pointing out that they were diverging negatively from price. Now that we are trying to identify a bottom, we want to flip things around and look at the percentage of stocks making new lows and registering oversold readings to see if these indicators are making bullish divergences. This would tell us that despite the continued selling pressure things are improving internally.
Let’s start with the percentage of stocks making new 52-week lows.
Not only do we have a bullish divergence, but it was confirmed yesterday as prices closed above their March 16th low where the percentage of stocks hitting new lows first peaked.
Click on chart to enlarge view.
Despite the S&P continuing to collapse, the percentage of stocks making new lows bottomed last Monday, March 16th and has been steadily declining since. While the S&P 500 made a significantly lower low Monday, the percentage of its components making new lows fell from about 60% last week to just 30%. During yesterday’s sharp rally not a single stock in the index made a new low.
This is the kind of breadth improvement we’re looking for.
Here is the percentage of stocks getting oversold, which we measure as a reading below 30 on the 14-day RSI.
Again, prices recently confirmed this bullish divergence in breadth that formed when the S&P 500 made a lower low Monday while the percentage of its components registering oversold readings declined significantly.
After looking at these charts it’s clear that despite the S&P falling another 6% from its March 16th low to Monday’s low (March 23rd), the market has actually strengthened beneath the surface as the percentage of new lows and oversold stocks has fallen dramatically. These kinds of bullish momentum divergences support our thesis that stocks should stabilize and start to carve out a bottom at current levels.
If you’ve been waiting patiently for a reason to start trading stocks on the long side, these breadth and momentum improvements combined with a well-defined risk level at the December 2018 lows are as good as any.
Volatility will continue as the market hammers out a structural bottom, but in the near-term, these improvements suggest the reward/risk has shifted back in favor of the bulls. If the S&P is back below its December lows, all bets are off and cash/patience remains best.
Thanks for reading and please let us know if you have any questions!