Trader’s Narrative

This is a tough market to navigate and the cross currents make things extra slippery. Perhaps it would be better to take a step back from the superficial index numbers and levels and look at the internal market structure. With that in mind, here is a chart for the New High New Low index for the Nasdaq:

It is a lesser known indicator but basically it compares the number of stocks going up and down. You can get more background information here, in case you’re unfamiliar with the new high new low index.

It is surprising to see that this indicator has been stuck consistently below 60 for the longest duration of time since the 2002 bear market. As the chart shows, this indicator stays low when we are going through a bear market and high when we are going through a bull market (as in the green box in 2003).

By the way, I’m showing a chart for the Nasdaq as opposed to the NYSE because the ever increasing number of non-common stock securities traded on that exchange has made most internal analysis of it fairly worthless.

In any case the chart above confirms what most of us know on an intuitive level: it feels like a bear market out there. Doesn’t it? Well, even though technically we aren’t in one. That doesn’t seem to matter. The tape is sluggish and the advance decline numbers also bear that out:

Last Friday’s weak market took us down to negative 1788 - extreme low advance decline breadth levels which we last saw in the swing lows of March (green arrow). But even so, it takes more than just one spike like that to wring out the market and set it up for a rally.

And in case you are wondering why I use the raw advance decline data, instead of the cumulative breadth data like most, it is because cumulative breadth is misleading.

For a strong and healthy bull market, either the advance decline must remain above such lows or when it does fall so low, it is preferable for a bouquet of extreme low readings which serves to flush out the weak hands (green boxes).

If you look closely, you can see what I mean about non-common stock securities ruining NYSE advance decline data. If you were only going by NYSE data, in June 2007, you would have mistakenly thought that the market was oversold.

So we seem to be in a bit of a limbo - not quite a bear market, not quite a bull market. Or maybe I’m projecting my own ambivalence onto the charts. What do you think?

Like other times of inflection in the stock market, we are seeing technical studies and indicators light up like a Christmas tree. So why not throw another couple stats on the pile? Below are the charts of new 52 week lows for the Nasdaq and the NYSE.

Similar to other indicators I’ve mentioned recently, this one spiked to a multi-year high last Tuesday (January 22nd 2008). In fact, you’d have to go back to the market turmoil we saw in 1998 to find a higher number of new lows!

The NYSE graph looks different mainly because a significant portion of the securities traded there are non-common stock but rather bonds, municipal bond funds and structured funds which are sensitive to interest rates. Nevertheless, we can see the same pattern.

As with the weight of all the indicators that I’ve looked at, this one is saying that it is time to look for buying opportunities, rather than selling or selling short.

I’ve mentioned several times that I prefer to look at Nasdaq numbers when it comes to breadth (in a non-cumulative way) because NYSE breadth numbers are “polluted” with non-common stock securities.

These are usually interest rate sensitive. They are municipal bond funds, bonds (yes actual bonds trade on the NYSE), CEF’s, and other weird and woolly financial concoctions.

The result is that these securities move like a great galloping herd. But they don’t move to the rhythms of the stock market. Rather, they take their cue from the bond market. So when you people get spooked about rates (thinking that we won’t see a rate cut or maybe even have a rate increase) these non-common stocks get clobbered.

And that effects the NYSE breadth numbers. Let me show you with one example. Here is the chart for BlackRock Municipal Bond Trust (BBK). Last week it sliced through its 200 day moving average (blue line):

Now look at the effect of moves like that one, multiplied by hundreds and hundreds of similar bond-like securities:

That is one really oversold market? Isn’t it? We are at the same extremes that we saw at the Feb-March 2007 market bottom. But are we really? Take a look at the Nasdaq advance decline numbers:

Oversold? What oversold? We are in neutral territory. And that is how the siren call of the NYSE breadth numbers can throw you off course.

If you’re interested to know how I trade these munis, take a look at My Year End Strategy.