Is Market Breadth Supporting a Rally or a Correction?

This is an excerpt from this weekend’s weekly market digest available to my premium members

“Other breadth indicators [Besides the McClellan Oscillator, and Advancing/Declining Issues] I track to help identify market strength and/or weakness are the Bullish Percent Index (BPI) charts. The BPI is a breadth indicator based on the number of stocks on Point & Figure Buy Signals within an index. The BPI varies between 0 to 100 percent. The higher the number, the more stocks are on a buy for the given index. When we look at the BPI for the NDX and S&P500 we see that only 56% of the stocks are -per their P&F charts- on a buy for the former, and 66% for the latter. In addition, there’s clear negative divergence (red and green dotted lines). This means less and less stocks are on a buy as these two indices march higher. Not healthy, and often leads to corrections. Note this means 64 of the 100 stocks in the NDX are on a sell. The S&P is only marginally better (66% are on a buy), as the Bulls are preferred with readings above 50, but readings >70 are preferred to signal a strong market.

Figure 1. A) BPI-NDX negative divergence and only 56% of all stocks in the NDX are on a buy. B) BPI-SPX negative divergences and still around 66% are on a buy

BPINASBPSPX

Like the BPI, we can assess market breadth by looking at how many of an index stocks are above their 200-day Simple Moving Average (SMA) charts (200AR). The more stocks that are above their 200d SMA, the stronger and well-supported the rally is. And negative divergences often foretell us of worse things to come. When we again look at the NDX and S&P500, we see large negative divergences (solid red and green arrows on NDX), with only 60% of its stocks above their own 200d SMA. Thus, less and less stocks are participating in the current rally. Note that these divergences can continue for a long time (dotted green and red lines on NDX), but the 200AR line has now been below its long-term moving average (blue line) for most of the year. The last time this happened was in 2015 leading up to the August decline (red boxes). Similarly for the S&P500; although its 200AR is healthier and confirming the current rally (dotted blue and purple arrows), there’s also on his index longer term negative divergence (dotted red and green lines), which is also evidenced by the lower long term average (blue line) now vs in 2015.

Figure 2. A) NDX200AR negative divergence, below its long-term average and only 60% of the index’ stocks are above its 200d SMA. B) SPX200AR slightly better than the NDX, but long term divergences and chart is more weak than strong.

ndxar200SPXA200R

Although divergences are only divergences till they are not, these 200AR charts align well with the BPI charts adding weight to the evidence that the current rally has more characteristics of a latter stage (5th wave) rally than that of a kick-off 1st wave or even a set of first and second waves. Price will eventually help tell the story, but for now the lack of participation must be considered as concerning.”

Arnout, Ph.D.

2014-06-10 17.07.27-small

Founder and President Intelligent Investing, LLC

Vice President NorthPost Partners, LP

Leave a Reply