Is market breadth telling the true tale?

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.

Charles Darwin

 

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

 

12 Comments

  • I have a question about the longer term USA/CAD chart. It appears to be breaking down through a trend line that goes back to at least 2014. Is the CAD is finally going to gain a bit of strength here?

    Reply
  • tnx for interesting food for thought…….when nortel was 30% of the tsx it also meant fund managers had to own it if they wanted to keep up with the index……….wasnt there also a drug company a while back that dominated the index and then went bust?…….

    Reply
    • Bruce
      Biovale, which turned into Valeant, which turned into Bausch–perhaps that is what you refer to? They were never as big an influence as Nortel–but yeah…they have been a yo-you story for sure.
      Heck, Bre-X was another interesting influence on the TSX. But again, nothing will compare to the effects of Nortel, based on its influence on the index

      Reply
  • Hello Keith
    Re “ask me anything”
    Many months ago you analyzed a number of the larger components of the Canadian technology sector and were quite positive about most of them. As a result I added to my position in XIT and this has done more than well. Thank you! The XIT has outperformed the US technology sector (XLK) during the past year and the Nasdaq in general (QQQ) while perhaps flying under the radar since it so very much smaller than the American counterpart. The fact it is smaller, however, should not obscure the fact that the XIT is characterized by a number of multi billion dollar components and that it is no longer dominated by one large company like Nortel or Blackberry. Recently, however, the XIT has rounded over and moved closer to its 200 day moving average, although staying safely above it. I’m debating whether this is a buying opportunity in a seasonally strong period for technology or a time for caution given the more recent weakness in the XIT. In doing some fundamental research on the XIT I have noted that RBC has currently “outperform” recommendations on its four largest components from a fundamental perspective. What do you think about the XIT from a technical point of view?
    Many thanks,
    Joe

    Reply
    • Joe I’ll answer this here rather than on the “Ask me” blog.
      You are correct about the concentration- CSU, GIB.A (disclosure–we own it), SHOP and OTEX represent 85%+ of that ETF
      Only CSU looks truly bullish. GIB.A (which we hold) is not bearish, but it is going sideways, consolidation pattern.
      The other two are rounding over or looking bearish. So, there is less of a bullish case to be made for the ETF-one bullish, one flat and two bearish positions—More of a case can be made for owning CSU or (assuming it doesn’t break) GIB.A. That is, after you do your own diligence on the fundamentals.

      Reply
  • re ask me-Canada has about 9 different exchanges,on any one day about 50% of the volume for any tsx listed stock can trade on these alternate exchanges.Does this mean the total short interest can be 30-50% greater than the short interest amounts listed on the tsx?stockwatch seems to be the only site to see the total volume at end of day.I,m curious

    Reply
  • re ask me. Chaiken money flow represents end of day buying by institutions. How is it smart/dumb money different and how is it calculated. Put/call ratio extremes are usually found at market inflection points(market gets it wrong). Have you done any studies on individual securities that show when option trade volumes are high the traders get it right or wrong.

    Reply
  • Hi Keith,

    Broad Markets keep making new highs. Is this fear of missing out? Have you increased or decreased your cash position?

    Do you think that there will be a pull back after tomorrow’s rate announcement?

    Thanks!

    Reply
    • We’ve been flat as far as investing cash –actually, we raised a bit last week and are slightly higher now but that was more of a rotational thing (out of REIT’s). We were just looking at research explaining the Fed patterns. Often a bit of downside on and a day or two after Fed day. I hope to buy in the next few days. Net net, we want to be in over the winter and want to be fully invested in the next week.

      Reply
  • What is impact difference in US vs Canada stocks with respect to the “Tax Loss” season?

    Could seem to find the ask anything link so posted

    Reply
    • Hi Bruce
      I wont post this in the ask me blog because its not a big enough subject. Basically, all tax loss selling must occur by settlement of the last trading day of the year on either US or Canadian stocks.
      Your broker can give you the appropriate dates for the last trading date.

      Reply

Leave a Reply

Your email address will not be published. Required fields are marked *

19 + 10 =

Topics

Topics

Recent Posts

Ask-Me-Anything-Blog-post-crop-e1361249771400

Ask Me Anything: Zoom Seminar

SPX PE

This market might be in a bubble, so profit by it!

S&P sector weighting

TSX looks bullish in spite of itself

gold

Gold oversold: Time to be bold, or should it be sold?

TAN

Green energy stocks extremely overbought

dow theory

Bear-o-meter neutral, with some caveats

cta-bg

Never Miss an Opportunity

Sign up for our newsletter to receive valuable insights that are available only to subscribers.   Beyond the blog – beyond the videos – get the inside scoop.

Scroll to Top