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Market Breadth Leads The S&P 500 Index Higher at Trader’s Narrative





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One of the reasons why market technicians believe that we are still in a primary uptrend is the incredibly strong advance decline lines for major indexes. The NYSE advance decline is the most common but I refuse to consider it an accurate measure of the stock market. Unfortunately, it has become too warped by the inclusion of non-operating company securities. Most of these are interest rate sensitive issues so they move in tandem with the bond market, not the stock market. This is why the NYSE breadth can mislead you and why I refuse to use it.

There are several ways around this. One is to look at the NYSE operating company only advance decline line. This is a bit hard to find because of the work involved but usually top notch firms like Lowry Research and Ned Davis Research have it. The other, more simpler way is to sidestep the whole issue by looking at the advance decline line of an index which is composed of operating companies. For example, the cumulative advance decline line for the S&P 500 index.

Click to see a larger version in a new tab:
S&P500 index advance decline line Mar 2010

This breadth measure is critical because it is telling us that as the S&P 500 index rises, it does so powered by a majority of its constituents. This is not a case where a few stocks are receiving the bulk of buy orders and dragging the index up grudgingly (like we saw in the later stages of the tech bubble in 2000). As well, if you caught the recent interview with Richard Dickson of Lowry Research, he mentioned that we are seeing the advance decline lines for major indexes lead the market higher.

You can clearly see that this is the case with the S&P 500 index advance decline line. It took the S&P 500 index itself until March 16th 2010 to decisively break above its January 2010 highs. But the cumulative advance decline line for the index surpassed its January high much earlier, on February 19th, 2010. But it has yet to surpass its previous high set on October 12th 2007.

Also, note that it set an earlier peak at 13592 on July 12th, 2007. And that if we step back, from early 2007 until early 2008, the cumulative advance decline for the S&P 500 index basically meandered sideways, unable to make headway in a concomitant uptrend with the index that it is suppose to track. Here’s a longer term chart for the S&P 500 index advance decline line going back to 2003:

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S&P500 index advance decline line long term chart Mar 2010

Usually advance decline lines will top out and start to decline ahead of major market indexes. Clearly we are seeing the exact opposite of that right now. The other market internal metric which is critical is the number of new highs. As long as we have the market showing a significant number of new highs, the bull market is intact. Historically, the number of new highs peaks ahead of the market by a year or so. Right now, we are seeing the number of new highs (or their relative number) hit new highs itself. So again, we are seeing the opposite of we would see at a major top.

Having said that, I am very cautious in the short term. While I do believe that we are still in a primary uptrend, based on these breadth metrics (as well as Wayne’s excellent recent post on tape reading) it is important to be cognizant of the short term clouds forming over the horizon.

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8 Responses to “Market Breadth Leads The S&P 500 Index Higher”  

  1. 1 GoodVibe

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    Hi, Babak. As you know, there are many ways to use Advance/decline numbers. Here is one way I use it - I hope it will add some value. On another note, I would like to thank you for all the great value I got from your site over the years. I share the same values of sharing you hold dear when you started this blog and this is why I come here frequently. My appreciation.

  2. 2 Babak

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    GoodVibe, you’re using a moving average instead of a cumulative adv/dec line. I do the same but for the Nasdaq because of the non-operating issue I brought up already. You can’t use NYSE data and not fall into the trap of seeing something that isn’t there because 30% of the issues are int. rate sensitive. I link to a specific example back in 2007 that shows the divergence between the NYSE and NASDAQ breadth.

  3. 3 MikeTaylor

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    Hi Babak,

    Could you view the current high Adv/Dec level as a contrarian sign showing irrational exuburance? People just buying up anything and everything as per the high levels reached in 2007?

    Great blog by the way, cheers!

  4. 4 Babak

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    Mike, you mean as an oscillator of sorts? I don’t think so. The cumulative AD line basically tells you people are buying everything under the sun - whether that is supported by a good case for the fundamental underpinning of the market or not… is irrelevant. As long as people buy a wide variety of stocks (or almost all of them) and push them higher, the market will go higher.

    A bubble is just a bull market you’re watching from the sidelines ;)

    ps thanks for the kind words, much appreciated.

  5. 5 GoodVibe

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    Babak, point taken. It was another way that helps form guidelines more than science. For your point, actually (as you said) the cumulative adv/dec line is lagging for me to call strategic tops or bottoms - see here - I rather use A/D ratio because:

    1. It remains constant. It has an absolute value that does not vary in function of the number of components being traded on the NYSE.

    2. It allows comparisons among different indexes or stock exchanges. For example, comparing the AD ratios of the DJIA and the NYSE is much easier than evaluating the AD lines for the NYSE and the DJIA.

  6. 6 PAUL MONTGOMERY

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    Hi Babak - where did u get that nice [first] S&P500 A/DL ?

    Looks like StockCharts, but didn’t hink they did it.

  7. 7 Babak

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    Both charts are from Bloomberg, the first is from the website and the second from the terminal.

  8. 8 PAUL MONTGOMERY

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    Thanks Babak - would like to see this chart more often - very insightful

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