Breadth divergence: Pending correction?

Market breadth is a measurement of the level of participation by the broader arena of stocks that trade on an exchange, vs an index. Or, it can look at the individual components of that index, and measure the stocks participating in a movement on a percentage basis. Either way, when you look at a breadth indicator of any sort, you are trying to see if an index is rising on a concentrated group of names (or sectors) vs a broad group of participants. One exception to that observation is when you look at the New high/ New low line, which I like to use as an overbought or oversold indicator. I’ve discussed that indicator in prior blogs, and at my recent MoneyShow talk which you can watch here I won’t be discussing it on today’s blog.

 

Generally speaking, most breath indicators are showing declining participation in the recent rally. It’s only been a short time – so we don’t want to react too quickly to this signal– this differs for the period leading up to the May highs on the market, where breadth was horrid for months on end. I blogged on breadth a few times in the spring, including a write-up on Dow divergence –which is a big-picture forward looking breath indicator – here’s the blog . BTW—Dow divergence is also happening at this time – that is, transports are underperforming the industrials. Here’s the chart:

TRAN

Below is a chart for the broad NYSE—all stocks that trade on the NYSE. Its reflecting that less stocks are participating in the current rally, as indicated by the current level, which is 7.5% below its May highs of 11,250.

nya

Compare that to the S&P500 index which of course is a focused index containing only 500 stocks. The S&P500 is only 2.5% off of its May highs of 2130 at this point. That’s quite a discrepancy.

S&P

The % stocks above their 50 day (red/black line) and 200 day (orange line) moving averages below shows us deterioration in breadth even over the rally that occurred during October.

stocks over ma

The cumulative Advance Decline line (www.freestockcharts.com) also shows us a few disturbing points surrounding breadth – specifically, as the S&P500 heads towards its old highs, the A/D line does not – and it – like the % over MA indicators noted above- has been stalling over the October rally.

AD LINE

All in, I’m becoming concerned about the current lack of participation by stocks in the current rally. Clearly, this is either a sign of a pending period of stagnation, or correction. My bet is that of stagnation—given the bullish seasonal factors. I also think that the decline in market breadth adds further credence to my belief that sector rotation is the name of the day. This is where smart individual investors like you, and small nimble Portfolio Managers like ValueTrend can really take advantage of the opportunities. Investors, Advisors and big Portfolio Management firms who don’t trade and rotate through these changes will be left for dead if markets gyrate as I suggest may happen.

 

Keep reading this blog, and keep your eyes open for the coming rotational opportunities you can take advantage of. Just as importantly,  look to sell sectors and stocks that round over technically, and avoid the pain that the markets will deliver to those who operate like it’s still “the good old days” of buy and hold.

 

Special BNN show with Keith Richards next Thursday 6:00pm

Despite the fact that I was just recently on BNN, I’ve been invited to participate in a special week of top BNN MarketCall guests next week. The entire week is featuring MarketCall’s most popular guests . I feel privileged to be participating in the event,  given the high quality of all of the guests that go on the show. My appearance is for next week – Thursday November 19th at 6:00pm. Be sure to mark this one in your calendar.

 

12 Comments

  • There’s nothing to get excited about in the S&P at these levels. Flat 200 day overhead resistance. You can talk about the seasonal factors but the charts don’t look that exciting.

    Reply
    • The one thing I am excited about is the rotational nature of markets lately –as I’ve noted on this blog–today’s hero becomes tomorrows zero and visa versa
      Frances H. at BNN put it well today in her market commentary, as she acknowledged the rotational nature of markets right now–her quote below:

      “For example, in consumer staples, at the top of the heap is Cott Beverages and near the bottom Saputo. In telecom, Rogers is now the best performing (couldn’t give it away a year or so ago) and the long-time favourite, Telus, now at the bottom. Healthcare, Extendicare is the best performing healthcare company and the hot as a pistol Valeant, at the bottom down 37% year to date. Sometimes, the last becomes first and first last”

      Reply
      • Wow, I am now seeing valeant down from $350 to $100 in a few months…… the next nortel? 😉

        Reply
  • Keith, lots of people miss out the Oct rally and hold large percentage of cash. Most of them are very bearish about the market. Does current decline present a good buying opportunity for contrarian view? Thanks!

    Reply
    • Hi Rebecca
      I am holding 10% cash and yes–I intend to spend it in the next few days–so yes, so long as you are buying into the right sectors, I would say this is a pending buying opportunity.

      Reply
      • Keith, just curious but in these situations when you put the 10 percent to work do you normally add to existing positions which may have gone down recently or would they be new positions/companies altogether?

        Reply
        • I’m looking to buy 2 new positions–we like to hold 20 +/- stocks to keep diversified, yet not “over diversified”. We hold this many stocks when fully invested for a specific reason–this comes from a few studies done (Ibottson, Concordia U. and others) on the ideal number of stocks to realize maximum upside with enough diversification to protect against securities concentration risk.
          The biggest problem with large portfolio managers is that they have too much money- thus they end up buying too many stocks–lest they face holding quantities that can never be sold in their volume. This gives them two problems–they cant sell meaningfully if markets look to fall – and they also end up performing at the index level plus or minus a couple of %. As a small shop–we are much like a small investor in that we can get away with owning a smaller number of stocks–but we still want to hit that “ideal risk/reward” number–again–somewhere near 20-25 seems to be the average by the studies out there –and we’ve found that to work for us.

          Reply
          • Thanks for the response and insight Keith. Much appreciated.

  • What sectors are you considering? Should we continue to be more patient? I rotated out of my bank positions. Is there a possibility to pick them up lower? Thanks.

    Reply
  • Hi Keith,
    The $SPX broke down from a head and shoulders pattern (30 minute chart over past 10 days) projecting a downside to around 2020. I see a possible tag of the 2000 area as well. I was able to trade the HVU over the past few days for a nice profit. Thanks for the blog about the correction and the sector rotation info.

    I’m looking to buy stocks soon, given where we are in the Sentiment cycle and especially if the market can tag a major support area. However, with the negative divergence in the market breadth, I am wondering if the upside is limited and/or short term (maybe retesting of recent highs or just chopping sideways). Am I reading too much into the poor market participation?

    Reply
    • Ron–I do believe that the broad market index (S&P500) will look flat and chop up/down for a while–but there will be stocks and sectors that will go up very nicely despite the flat broader market. Some too will drop like rocks. Its already happening–witness the demise of healthcare, and the re-emergence of telecom here in Canada. Oil’s failed summer rally rotated money into sectors like the banks (both sides of the border). I can think of lots of examples. Call it a “stealth” market–if you are investing like a stealth fighter, silently zipping in and out-without bias or prejudice–you will win!
      The divergence in breadth is something to keep an eye on–that’s why I wrote the blog, but at this point its relatively short lived. It may morph bigger, but that’s to see. That’s the lovely thing about TA–a good technician is agnostic. Non committal, non thematic, non-believing in any theme or prognostication–we simply go with the flow. As such–we get to change our minds the moment we discover a new trend. If breadth keeps looking bad, and the other factors I look at signal caution (VIX, Sentiment discrepancy between dumb/smart $, etc) I will go bearish. But–that’s to see.
      For now, I am bullish, with a sector rotation angle to that bullishness.

      Hope that helps.

      Reply

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