It is not the strongest of the species that survives,
not the most intelligent that survives.
It is the one that is the most adaptable to change.
I view breadth as a sign of a markets health. Traditional market breadth indicators are things like:
- New high/low indicators
- % of all stocks on an index above various moving averages
- Cumulative advance decline line, etc.
The problem with many of these indicators (not all of them) is that they focus on an underlying index that may consist of a relatively limited number of stocks. For example, a breadth indicator that measures New Highs vs. New Lows on the S&P 500 is limited to 500 stocks. This, in comparison to the 2800+ issues listed on, say, the NYSE. Or the 3671 total listed issues on all US stock exchanges. Perhaps a more widely diversified index means better representation of breadth.
The value line arithmetic index (VLE) is thought by some to be a more “true” representation of the market. Its an arithmetic index, giving equal significance to a wide dispersion of stocks. Some 1675 stocks are represented equally. Their individual % gains are totalled, and then divided by the 1675 figure to give a “true” representation of what the market did on a given day. This, instead of a weighting assigned to a concentrated number of stocks – as most common indices do.
The arithmetic calculation of prevents distortion. In a capitalization weighted index like the S&P 500, larger capitalization stocks end up being overweight in the index. You could argue that they are deserving of that weight in the index, given that the capitalization represents where the money is, so to speak. However, this type of weighting distorts the balance of the index, and can cause a false view of a market’s breadth.
For example: The most perverse distortion I have witnessed in my 30 year history as an investment professional was in the late 1990’s when Nortel reached over 30% in the TSX 300 as a weighing. Come on, guys! One stock is 30% + of the index, and the other 299 make up the remainder? Nortel ended up going bankrupt just a few years later. That kind of thing can cost a bit of lost confidence in a market index. Since then, that index has toned its weightings down a bit to prevent such future mishaps. But its still a cap-weighted index. You can see why some might prefer an arithmetic (equal weight) index like the VLE. One can argue that a larger representation of stocks with an equal weighting makes a better market health barometer.
You can decide if the VLE is a more intelligent index to trust, or not. But I will note that it is not putting in a higher high…..or anywhere near it!
This, while the cap-weighted less diversified S&P 500 put in a new high last week…..
Come to think of it, the broad based NYSE index is also struggling. Its a free-float weighted index, and it contains 1900 stocks listed on the NYSE. Hmmmmm….
Perhaps the new high on the SPX is a bit illusional. Or not…perhaps the cap weighting really does make the SPX a better representation of the market’s health. Either way… a lack of highs on the broader indices does make me question the strength of the market.
Reminder: Ask me anything deadline for questions this Wednesday October 30th