From the desk of Steve Strazza @Sstrazza.
What’s with all this talk about weak breadth lately?
A lot of market participants have been pointing out the divergences or lower highs in popular breadth indicators such as the percent of S&P 500 stocks at new 52-week highs or the percent above their 200-day moving average.
In many cases, these actually aren’t divergences at all as the S&P is yet to make a new year-to-date high itself.
Just like we look at different breadth indicators to identify market tops than the ones we look at to signal bottoms, we should use different items in our breadth toolkit depending on the market environment we’re in.
Using the current rally as an example, it makes little sense to give weight to the percent of stocks making new 52-week highs considering most indexes and sectors haven’t been able to achieve the same.
Although, there are other metrics like the percent of stocks making new short-term highs and the percent hitting overbought momentum readings that can give us a lot of information about market internals right now. In this post, we’ll dive into these charts to see what they’re currently telling us.
First, let’s look at the percent of stocks making new 52-week highs for perspective.
Click chart to enlarge view.
Lower highs in the S&P and lower highs in the percentage of stocks making new 52-week highs. While this definitely isn’t a bullish divergence, it’s not a bearish one either. It’s just ordinary price behavior.
If the S&P isn’t at new 52-week highs like it was earlier in the year, why should we expect more stocks to be at a higher price now than they were back then? Doing this type of analysis in the current market is a cheap trick. We’re paying little attention to this indicator until we get new highs at the index level.
The percentage of new short-term highs in the S&P is a much better representation of current market internals, and right now it IS flashing a bullish divergence.
We use new 63-day highs as it represents the equivalent of roughly a quarter in calendar days. Similarly, 21-days is about one month.
Notice the lower high in price but higher amount of new 21-day and 63-day highs between now and Q1. In fact, it’s a rather significantly higher amount. The percentage of stocks making new short-term highs today is about twice what it was when internals peaked in January, just before the market rolled over. It’s safe to say that breadth is much more supportive of today’s rally than during Q1.
Let’s zoom in on the new 63-day highs now.
Notice how the percent of new highs has been steadily increasing during the current rally and confirming each new high? This is what an expansion in breadth looks like.
Now contrast this with the January-February period, whereas the percent of new highs was falling despite the index making new highs.
This is an example of a bearish divergence as breadth failed to confirm the new highs and gave us an excellent warning signal that the current bull run was losing steam. We’re simply not seeing the same thing today.
This is a rare signal as it’s only the eighth time we’ve seen such an extreme reading in almost 30-years. June 8th marked the highest reading since December of 1991, which is just when the S&P was kicking off a decade long rally that returned close to 300%.
This table shows return statistics following each bullish reading marked on the chart above.
As you can see, strength tends to follow these momentum breadth thrusts as the index was higher by an average 7.5% the year after readings above 35%. Stocks were higher across all timeframes on 6 out of the 7 occurrences. Not a bad win rate. In fact, the signal generated very favorable forward returns after every occurrence except for the most recent in January of 2018. Stocks were lower by almost -7% a year later.
Even short-term performance has been excellent following these extreme readings, so regardless of your timeframe, this is a bullish development. If history is any guide, then chances are you’ll look back a quarter, or even year from now, and be glad you bought stocks… if you did.
Long story short, there are a myriad of ways to analyze breadth and internals, but that doesn’t mean they are all appropriate or applicable for the current market environment. We could show you some charts that paint a picture of weak breadth and scare you. It would probably get more clicks… but it would be misleading.
All that matters is the breadth indicators that are relevant to today’s market are flashing the green light for now. We’ll be the first to let you know when this changes.
Should we be more concerned about the lack of new long-term highs, or are we looking at this right?
All Star Charts Team.