Aren’t calendars wonderful? A couple of days ago, up pops a reminder on my calendar to revisit a post I did a year ago. At the very beginning of 2016, I wrote a post on whether yearly performance was mean-reverting, and found some interesting things. You might want to go back and take a look first, before you continue reading here.
Recently I posted a number of articles on various breadth diffusion indicators and their relative effectiveness in predicting the health of the S&P 500. The big winner was the system that compared the number of stocks in the historical constituents of the Russell 3000 that were up 30% or more over the last quarter (60 trading days) vs those were 30% or down over the same period. You can read the whole series here.
The breadth diffusion value is computed as (up30 / (up30 + down30))*100. Suffice it to say, we have been seeing very low numbers recently. The current value is 8.2. So I thought I’d go back and see what those low numbers have foretold in the past.
Looking at the period of 1/1/2000 through 12/31/2015, we have had only twenty times that the diffusion value has dipped below 10. Below you can see all 20 of them, with the diffusion value, plus the 5, 10 and 20 day gain/loss for each instance:
The average 5-day gain/loss of the S&P 500 is 2.9365%, while the average 10-day G/L is 5.4655% and the 20-day G/L average is 6.3975%. The 5-day period following such a low diffusion number has been positive 75% of the time, the 10-day period has been positive 90% of the time, and the 20-day period 80% of the time.
All that to say a bounce seems likely.
I track some breadth indicators, one of which the number of Russell 3000 stocks that are either up or down 30% in the last quarter (60 trading days to be exact). Above you can see how many are down 30% in the past quarter: it’s the highest we’ve seen in over two years. While I’m not one to predict things unless I’m sure I’ll be right, this demonstrates profound, sustained weakness. It’s not just a narrow spike, but a steady, inexorable climb.
July through November 2014 shows a strong increase in the number of stocks making the Neg30Qtr list.
So what about the positive side of things? Aka the Pos60Qtr meter?
It’s been worse, but not much worse. At the same time October 2014 was showing a high number of stocks suffering greatly, it also shows there were many stocks doing quite nicely. A wider breadth, in other words.
Let’s look at the difference over time between the Pos30Qtr and Neg30Qtr indicators. Note the blue horizontal line is zero, i.e. there would be equal numbers of +30% / -30% stocks at the zero point.
This is the most negative the Dif30Qtr indicator has been in two years. In fact, it’s worse than the “taper tantrum” of early 2014, and the plunge of October 2014.
Conclusion: while the market – or more specifically the S&P 500 – is maintaining a relatively narrow price band, the wider universe of stocks is suffering greatly. There is evidence to support this by looking at the S&P 500 Equal-Weight index, which shows considerably more weakness than the market-cap version. In other words, there appears to be a few giant companies propping up the index, which is hiding a weakness in the wider markets.
Sheesh, now I sound like a SeekingAlpha Bear-Monger.
I track the weekly change in the Commodity Futures Trading Commission’s “Commitments of Traders” report. This report provides the number of futures contracts committed to each week by large institutional traders, hedge funds etc. While it doesn’t predict the future, it can tell you what the Big Money thinks the future will be. Sometimes that’s the same thing!
I graph a short momentum indicator of the change in the ‘long’ position from week to week. Next week looks like it might be an ‘up’ week, at least for the NASDAQ and S&P 500. The Dow shows a declining momentum, although it’s still positive. Caveat emptor.
One thing to keep in mind is that the data shows the state of the futures market through Tuesday, but the report isn’t released until Friday. So there’s a delay there, where many things can happen.
The green line is the SPY ETF, used as a stand-in for the S&P 500. The other lines are the momentum indicators.
You may remember I described a divergence signal I came up with for a market-breadth indicator a few weeks ago. I won’t bother to explain it again (you can read all about it here).
We have ourselves a positive divergence signal from today’s trading. Basically, the S&P 500 went down, while a particular subset of advancers vs decliners went up. You can see this by the red vertical line below.
Should you trade based on this indicator alone?
Yes! No! But consider it when thinking about a trade tomorrow. As I described in the earlier post, there’s a better-than-even chance tomorrow will be an up day.
Disclaimer: all trading involves risk. Trading based on something I’ve said entails additional risk, and is not suited for all investors. Especially those with money to lose.