Trader’s Narrative

One of my favorite breadth charts is the Bullish Percent Index. It isn’t as common as advance decline measures because it is based on point and figure charting.

Point and figure charting itself is based on pure price action and ignores both time and even small price movements. In P&F charts the X represents demand (or bid or buying) and the O supply (or selling). Unlike candlestick or bar charts, it is perfectly normal for a point and figure chart to not need to be updated (when price doesn’t move beyond a threshold either up or down). This is the great advantage of point and figure charts.

Other than that, the basics of technical analysis such as support and resistance apply to point and figure charts. Also, point and figure charts can provide systematic buy and sell signals - something that ‘normal’ charts leave open to the traders discretion. The simplest buy signal is the chart to the left - when price breaks above a previous high (without the column of O’s breaking below their previous low).

So to calculate a Bullish Percent Indexes, we simply take a look at each and every stock compromising an index and track how many of them out of the total constituents are in a point and figure buy signal. If, 120 out of the 500 stocks in the S&P 500 index are in a buy signal for example, then the Bullish Percent Index for the S&P 500 for that day would be 24%.

Doing this by hand would be extremely cumbersome, but thankfully we have computers that can do the calculations in a fraction of a second. Here is the chart of the Bullish Percent Index for the Nasdaq Composite:

According to the traditional interpretation, a Bullish Percent Index of 70% and higher is considered overbought. And if there it experiences a 6% (or more) decline, it will offer a sell signal. Personally, I prefer to not wait for the sell signal. Once you know that the market has weak legs, you can use other indicators to give you more short term guidance.

Right now we are seeing almost every single measure of the market provide extreme breadth levels from the Bullish Percent Index. Normally seeing the bullish percent indexes for so many markets and sectors reaching this high in synchronicity would be a red flag. However, there is an argument for such strong momentum to be a signal of a protracted rally.

This was the same concept that I shared earlier this week about incredibly powerful thrusts measured from the advance decline breadth. These short busts of powerful buying are usually precursors to lasting uptrends. Think of it as a turbo booster on a rocket which lifts it through the heavy atmosphere before it can glide easier through the thin air of space.

Consider that the last time the Nasdaq composite BPI was this high was back in 2003-2004 during a powerful bull market. It is the same case for the NYSE, and the Nasdaq 100 index. This is how oversold can become meaningless.

Bullish Percent for Major Indexes:

• NYSE Index — 77%
• Standard & Poor’s 500 — 83%
• Nasdaq Composite — 70.55%
• Nasdaq 100 Index — 90%
• Dow Jones Industrial — 77%

Bullish Percent for Sectors:

• Financial — 86%
• Consumer Discretionary — 79%
• Consumer Staples — 73%
• Energy — 60%
• Healthcare — 79%
• Technology — 87%
• Industrial — 71%
• Materials — 85%
• Telecom — 56%
• Utilities — 62%
• Transportation — 75%

One of the signs of the tech bubble was how Information Technology as a sector ballooned from less than 6% (in 1989) to 29.18% (in 1999) in relation to the S&P 500 capitalization. Turning that idea on its head, let’s take a look at the financial sector during the past few years as a ratio of the general market.

As a caveat, let me reiterate that bull and bear markets within the financial sector don’t correspond to the general market: Does a bull market need financial stocks leadership? While at first it may be counter-intuitive, the data backs up the conclusion as you can see from the link.

But nevertheless, following the weight of sectors within the total market capitalization can help us in getting oriented. So I looked at the Standard & Poor’s Financials sector which includes the following sub-sectors (and more):

• Banks
• Consumer Finance
• Diversified Financial Services
• Real Estate Investment Trusts
• Insurance Brokers
• Life & Health Insurance
• Multi-line Insurance
• Property & Casualty Insurance

Here is the annual weight of the financial sector and the banking sub-sector relative to the S&P 500 capitalization (the charts below are interactive so mouse over for details). I was surprised to see that the financial sector topped out in 2006 at a whopping 22.27% of the total value of the S&P 500 index. That’s almost 3 times what it was in 1990:

Zooming in, we can see the monthly weight of the financial sector as a percentage of the total S&P 500 index capitalization from the start of the most recent bear market:

At the extreme low, set in early March 2009 just as the rest of the market was making its recent low, the financial sector reached a critical level it hadn’t seen since 1990! Since then it has jumped to 12.6% as the financial sector has lead the recovery in the general stock market. While no one knows if this is the definitive bottom for the banks, we can say that the March lows were a major low where the sector was as unloved as it has been for the past 20 years.

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Who could have imagined that with crude oil at +$110, the transports would be one of the highest relative strength sectors out there?

Well, if the stock market was strictly logical we would have figured it all out centuries ago. This is exactly what makes trading so fascinating.

Bullish Percent
The recent swing low was in early January, when the bullish percent for the sector reached a measly 5%. Five percent!

Do you know the last time they were that low? Try July 2002.

But since you’ve read my post about timing the market with bullish percent charts, you know all about that and of course, took obscene advantage of it. Of course.

But there’s more going on here. Take a look at this chart:

The top chart shows the relative strength of the transports (to the S&P 500). Notice the higher lows and the higher highs. Then check out the completed head and shoulder formation with a nice quick retest of the neckline.

Believe it or not, it has already made it to the October 2007 highs. In contrast the Dow Jones Industrial average is still well below that area on its chart.

Dow Theory
According to Dow Theory, major signals are given when the two major sectors (sometimes along with the third: utilities) confirm each other.

While the recent action is not bullish per se, at least according to strict Dow Theory, it sets up what is called a “non-confirmation” - in this case, for a decline. That is, because the Dow Transports didn’t confirm the lows that the Dow Jones Industrial Average reached but instead headed up.

What would be truly bearish, according to Dow Theory, is if both the Dow Jones and the Transports print prices lower than their January levels.

So right now what we have is simply the potential for a buy signal, if the Dow Jones continues to rally and rises above its February highs.

Over the past few months I’ve received this question more than any other:

Where do you get your bullish percent data/charts?

So instead of answering each person individually, let me write about it so everyone will benefit - and leave me alone!

There are quite a few places to get bullish percent data but I use StockCharts.com. They not only track bullish percent charts for 18 different indices and sectors, they have an impressive amount of historical data which comes in handy when you want to compare current market conditions with previous times.

StockCharts also allows you to create your own bullish percent index for any grouping of individual securities. So if you find that the 18 sectors or indices they follow:

• Nasdaq Composite Bullish Percent Index
• S&P Consumer Discretionary Bullish Percent Index
• S&P Energy Sector Bullish Percent Index
• S&P Financial Sector Bullish Percent Index
• S&P Healthcare Sector Bullish Percent Index
• DJIA Bullish Percent Index
• S&P Industrials Sector Bullish Percent Index
• S&P Technology Sector Bullish Percent Index
• S&P Materials Sector Bullish Percent Index
• Nasdaq 100 Bullish Percent Index
• NYSE Bullish Percent Index (the original and most widely followed)
• S&P 100 Bullish Percent Index
• S&P 500 Bullish Percent Index
• S&P Consumer Staples Sector Bullish Percent Index
• S&P Telecom Services Sector Bullish Percent Index
• DJTA Bullish Percent Index
• TSE Bullish Percent Index
• S&P Utilities Sector Bullish Percent Index

…isn’t enough, just make up your own bullish percent index! or replicate an existing index (first, you’ll have to obviously find out all the constituents).

This is a great feature if you follow an obscure sector like say, palladium stocks or gaming/gambling stocks, etc. Or if you simply want to create a bullish percent index for the stocks you hold as long term investments to know when to lighten up and when to add to your positions.

The only disadvantage is that this feature is not free. You’ll have to subscribe to StockCharts. But their rates are very reasonable so if you are serious about technical analysis, you shouldn’t hesitate.

The other online resource for bullish percent charts is Tom Dorsey’s website. He wrote the bible on point and figure charting, which is the foundation of BP index charts.

Only problem is the website (behind the subscription firewall) is incredibly clunky and difficult to navigate. It seems like something his 12 nephew threw it together on a weekend… in 1994.

There was a chart request for the Philadelphia Semiconductors Index, otherwise known as the SOX.

The analysis is simple, but perhaps not too satisfying. This stalwart of the tech sector has been stuck in a meandering channel for more than five years.

The upper range is ~550 (resistance) and the lower range is ~360 (support) - where the index is now. During the wicked bear market of 2002 (and the early part of 2003) the SOX penetrated the lower range temporarily.

The bear market panic low, near 200, revisited a level previously reached during the 1998 LTCM/Asian currency crisis low. If the channel support doesn’t hold, this is where we would be headed, ultimately.

But while the sideways channel may give us a picture of a sector that is treading water, a relative graph shows that this sector has been a consistent loser:

Semiconductors roared out of the bear market lows of 2003 leading the general stock market higher. But while other sectors went on to a continued cyclical bull market lasting multiple years, the SOX’s rally petered out in 2004.

Since then, they have never really taken the lead and instead have reached relative lows approaching those of 1998.

While value investors may be attracted to the valuation of semiconductor stocks, I would stay away from this sector until it can show that it has either broken down (offering shorting opportunities) or until it eventually builds a base out of all this sideways action and once again is ready to resume leadership of the market.