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An Important Breadth Indicator Breaks Down at Trader’s Narrative

Last week, as the market weakened, I mentioned that we were at a point that had resulted in a bounce in prior corrections: Market Falls Into Short Term Support Once Again. But of course, we didn’t bounce and instead fell further. If you look closely you can see that the market did make an attempt intraday to bounce off those oversold conditions but it failed:

SPX VIX compared Jan 2010

The tell-tale signs are the upturned ‘whiskers’ in the candlestick bars. More technically they are called reverse hammers. Interestingly enough the CBOE Volatility index (VIX) fell as the market went sideways and now it is lower even though the S&P 500 is lower.

On one of my favorite breadth measures is the percentage of S&P 500 stocks above their 50 day moving average. I have pointed out an important pattern in this this indicator for a while now. Most recently at the start of the correction. From October 2008, when it bottomed ahead of the stock market in this cycle this breadth indicator had put in a successive of higher lows indicating the strength of the thrust higher. But that is no longer true. As of last week this clockwork pattern broke down.

percent SPX above 50 MA Jan 2010 update

We don’t have to look far back in history to see a very similar pattern. In mid-July 2002 before the S&P 500 itself bottomed the percentage of S&P 500 stocks trading above their 50 day moving average fell to basically zero (0.20% if you want to get technical). Then in the following months, it went higher, charting a course of higher highs along with the market.

percent spx above 50 MA 2002-2004

Until March 2004. That’s when it fell below a previous low (36%). What followed was a very challenging time period for the bulls as the S&P 500 trudged along barely being able to go sideways. It wasn’t until November 2004 when the S&P 500 finally traded higher after 8 months. Are we going to see a similar consequence play out for the market? No one really knows of course but this market continues to replay the past bull market to an eery degree (Comparing Flag Formations: Then & Now).

SPX 2002 bottom and cyclical bull market

The only major difference between the current pattern and the one in 2002-2004 is that back then the longer term breadth measure, the percentage of S&P 500 components trading above their 150 day moving average, broke down as well, falling to 62% and then lower. Right now that isn’t happening with the same indicator. Currently there are still a lot of stocks above their longer term trend line (76%) which suggests a healthy overall breadth.

Keep in mind that the stock market is still trying to process a rare overbought condition. In mid September 2009 the S&P 500 index traded above its long term average by 20%. For more information about this see: What Happens This Far Above The 200 Moving Average? Since 1950 that’s only happened a handful of times. And each time, the market has a very tough time pressing forward. Within a few weeks it will be 6 months since the overbought signal and we’ll be able to calculate the return. But if it is within historical norms then we shouldn’t see much gains.

For more analysis on this, and a different perspective, see the recent Decision Point commentary here.

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2 Responses to “An Important Breadth Indicator Breaks Down”  

  1. 1 Speculation

    I think we will make it back to the old highs, but from there will probably rebound trading in a range.

  2. 2 Speculation

    Using historical data from past recessions, I calculated what unemployment might be in 2 years assuming Friday is the top in jobs. I also calculated the average market rise during that two year period. This chart shows what I came up with.

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