Every now and then it's time to check in on the market's vital signs. Like a nurse, we need to check the market's breadth, momentum, sector strength, and trend. In this way, we can get an early clue to the health of the market and in our case, understand the strength of the current trend since the October bottom. I'm going to continue Chris Puplava's health check from yesterday looking at similar indicators and more.
What's the first thing a nurse does before they exam a patient? They wash their hands or put on gloves so they don't contaminate the patient. Likewise, gloves help protect the nurse. So the first thing we want to do when checking the pulse of the market is leave our biases at the sink. Wash your hands from your bearish or bullish views on Europe, U.S. debt, and China's hard landing versus soft landing debate. Don't be a perma-bear or bull. Think like Marc Faber who is bullish on stocks when the timing is good and bearish when the timing is not. Play the market, don't let the market play you. So, we're going to take an objective look at the market via technical analysis. Even in technical analysis, it is easy to paint a bullish or technical picture, so be careful and leave your biases at the sink.
Technical analysis is an objective look at the market. Since I began specializing in the skill in 2004, about nine years after I started working in the business, it amazes me to this day how many financial professionals use it as the primary source to pick investments or trade. On days like yesterday when Freeport-McMoRan (FCX) breaks below a support level, it's no wonder 30 million shares swap hands in a day when the average is typically around 16 million – all because traders and investors alike saw a technical level give way. Freeport announced a dividend yesterday, but it wasn't paid yesterday so the drop wasn't explained in a dividend payment. So we weren't looking at any fundamental reasons why the stock should have sold off. It just did because tens of thousands of eyeballs saw the same thing I did, FCX breaking support.
Checking the Temperature Levels
Starting off, I'd like to reiterate some of the level divergences I spoke about last week. Before this Monday's strong rally, the resistance levels to break were: S&P 1415, Dow 13,300, NASDAQ 3091, and RUT 844. Thus far, The S&P 500, Russell 2000, and NASDAQ Composite broke free of those levels on Monday. This time, the Dow Jones Industrial Average (DJIA), in addition to the Transports, didn't participate and held below the March 16th intraday high at 13289. The intraday high on Tuesday was 13264. While the major averages have reversed below those levels, it is not a long-term warning sign that should be overly emphasized. The DJIA hit 52-week highs within March and that is the main story here that shouldn't be ignored despite the recent action in the industrials and transports. The transport index is another matter entirely, but I talked about that at length last week. You can read about it here if you missed the article.
Take a Breadth
One of the market breadth indicators I check actively is the percentage of stocks above short, intermediate, and long-term moving averages. It tells us how broad based a rally is. When fewer stocks are participating in new highs or fewer companies are trading above moving averages, it hints at forming market weakness. The percentage of stocks above the 10-day moving average is too whippy and sensitive to weekly movements. We want something with a little less sensitivity. I believe that the percentage of stocks above the 50 and 200-day moving average are two indicators that none should be without when following the equity market.
Here is the percentage of stocks above the 50-day moving average. There are four themes to notice here:
- The equity market is in overbought territory above 70%
- The recent March 26th high showed fewer stocks in the S&P 500 above the 50-day MA (orange)
- This indicator has briefly traded below 70% for single days at a time which indicates how strongly dips are being bought
- Each correction in the S&P 500 since the October bottom shows a higher percentage of stocks trading above the 50-day MA (blue trendline).
Source: TradeStation
(I apologize for the black chart if you're printing this. Stockcharts.com hasn't updated this indicator for today's data)
The longer-term breadth indicator is the percentage of stocks above the 200-day Moving Average. The indicator has produced fewer signals and each signal has had a longer time span. Stock Charts doesn't show today's figures yet, so I'll tell you it has dropped down to 82.7% - still well above 70%. A drop below 70% is a sell signal.
There are a few other breadth indicators that are helpful to check the pulse of the equity market. We want to know how many stocks are participating in the advance versus declining. Whether the rally is broad and strong with 90% or more issues advancing or whether the only a few stocks are holding up the market (the large-cap generals), it makes a big difference. In addition to the advancing versus declining stocks, there's the net number of equities hitting 52-week highs versus 52-week lows. These are all breadth indicators that talk to us about the health of the market.
One of the strongest indexes since the October low has been the tech-laden NASDAQ Composite. Here, we will not find any closed-end bond funds to skew the data. So the new highs versus new lows and advancing versus declining issues indicators should primarily relate to common stock, REITS, tracking stocks, limited partnerships, and American Depositary Receipts. The NASDAQ Composite is not the same as the NASDAQ exchange – a minor detail.
In the chart below, I wanted to show some recent developments for these two breadth indicators. For starters, fewer companies hit 52-week highs from the March rally from 2900 to 3130. In addition, the cumulative calculation of the advancing versus declining issues has been stuck at the February highs, suggesting that this recent leg up has not been as broad based as the January and February advance. Rather, it is becoming market-weight led by fewer companies. Did anybody say Apple? That doesn't give the rally any less credence, but it is a warning sign that the trend is getting tired.
How Do You Feel
Beyond looking at breadth, another check we can employ is sentiment indicators. How bullish are investors and how bearish are investors. The last time I checked the Investor's intelligence survey, which tracks the advice of newsletters, it read that the number of bearish investors is down to 23.6% a week ago, one of the lowest figures since July last year. Additionally, we have the CBOE put to call ratio for equities to understand sentiment. While we're well off the bearish extremes we saw in October, we're currently testing the same level as July last year. It's not a bullish extreme as in May of 2010, but it does show that investors have started to buy puts again versus February as the indicator has started to tick up as of late.
Despite market sentiment lifted to bullish levels, I find it rather contradicting that it doesn't match what managers and retail investors are actually doing. The Investment Company Institute tracks fund flow data. It shows that over the past eleven months (minus February), money has been leaving equity mutual funds. Money has been flowing into bonds for eleven of the last twelve months. The chart below shows the data going back to 2007.
Recent data shows no change in trend. While fewer dollars have left equity mutual funds than three months ago, the market has rallied 26% and we still don't have positive fund flow heading into equities which continues to reiterate that the market is climbing a wall of worry.
Source: https://www.ici.org/research/stats/flows/flows_03_28_12
So while newsletter writers can change their tune and become more bullish as of late, that doesn't mean that Joe "Investment Advisor" Doe has listened or that Jane "Baby Boomer" Doe has exited her bond funds in her 401k to buy equities. Some will argue no duh Sherlock. Many aren't comfortable with the market volatility after seeing two bear markets in the last twelve years and 10-15% corrections over the summer over the last two years. However, from a contrarian prospective, this is good for stocks. While the technical picture doesn't feel like it could get any better, fund flow data shows that there's plenty of room for improvement.
Conclusion
Fundamentally, we continue to hear about worries over China slowing. Most of the G-8 would kill to have the kind of growth rate China has. The classical criteria of a recession is two consecutive quarters of negative GDP. GDP slowed to 8.9% in the 4th quarter of 2011. The debate will continue for some time until we see the Purchasing Managers Index data back above 50 (March flash numbers were at 48.1 last week). Housing data continues to look grim for China. Europe's PMI data has also ticked down as of late from just under 50 to 48.7. On a scale of 0-100 where 50 is the breakeven point, that's still pretty close right? So while perceptions have skewed to the negative side regarding China and Europe, stocks in industrials, materials, and energy have begun to underperform the S&P 500 ytd.
YTD performance is concentrated in financials, technology, consumer discretionary stocks. The risk-on trade is half off! That's also a little concerning for the month of March. While some macro economists may argue that means we've got a while yet for this cyclical expansion because we haven't had a run yet in late-stage cyclical stocks, it would be concerning if we start to see the risk-off trade outperform in April via healthcare, staples, and utility stocks. So watch these areas with care. The recent Supreme Court debate over the Constitutionality of Obamacare and its mandates may be skewing that trade this week, but the charts for healthcare are starting to look attractive again. There were some big moves today in the health insurers, but healthcare started to tick up in Pharmaceuticals at the beginning of the week for the first time in almost three months. Look at Coca-Cola (KO). Staples are also starting to improve their relative performance, about the same time they did last year.
While the trend continues to be our friend in equities, there have been some cracks in its structure in March. Time for a breather? The market hasn't corrected in a meaningful way since December. The longer it trends higher without a meaningful correction, the more antsy investors and managers will be. Long-term breadth and momentum indicators have been holding in overbought territory while the trend continues higher. The importance, however, must always rest with price. So continue to keep your focus there with short-term support levels at 1385 for the S&P 500 while this article should tell you, "I need to raise my alert status to possible change". Vital signs continue to point towards long-term bullishness while short-term indicators look tired, hinting a 5% consolidation or less may be in store. Momentum divergences in hourly charts point towards short-term weakness while breadth indicators suggest the trend is weakening. But even today, the intraday low was nowhere near the close. Weakness continues to be snatched up.
A 5% correction from the highs wouldn't be the end of the October rally. Tops take time to work themselves out. The topping out of the S&P 500 last year took five months. A trend as strong as this one, that has risen steadily, unlike silver in April and gold in August last year, won't end so quickly. Let's follow price first, but let's also continue to check the market's vital signs to gauge its health.
