The Financial Post takes a weekly look at the tools and strategies that will help make your investment decisions. This week: What market-breadth indicators are telling investors.
Corrections have been a hot topic this month, with many analysts pointing to some worrisome market-breadth indicators as cause for concern.
There are a variety of breadth indicators that analysts look at when trying to gauge the direction of the market. A popular one compares the amount of stocks hitting new 52-week highs versus those hitting 52-week lows. Another looks at the number of stocks advancing in trading sessions versus those declining.
Ron Meisels, founder and president of Phases & Cycles Inc. in Montreal, said market-breadth signals have recently shown some bearish tendencies, but the current readings are to be expected in a correction and don’t necessarily signal something worse.
“Yes, we have had a divergence, but it’s not the kind of divergence that can lead to a bearish selloff,” he said.
The number of stocks reaching 52-week highs on both the S&P 500 and the S&P/TSX Composite indexes has dramatically declined in the past month, while the number reaching 52-week lows has increased. That signals negative market breadth.
At the same time, the number of stocks advancing as opposed to declining has flipped since their peak a couple of months ago, with more stocks now dropping than advancing on both indexes.
Some analysts see the current trends as a reason to get bearish on stocks. A popular measure of market breadth among the bearish crowd these days is the Cook Cumulative Tick, or CCT, created by veteran investor Mark Cook.
The CCT uses the New York Stock Exchange’s Tick Index, which gauges the number of stocks trading up versus the number trading down, and compares it to share prices. The Tick Index is moving down while share prices are moving up, creating a significant divergence that hasn’t been this wide since the market crashes of 1987, 2000 and 2007. For the bears, the CCT is a sign that the current correction is heralding something nasty.
Other breadth indicators are also showing signs that the stock market rally is starting to grow long in the tooth.
“Small cap under performance relative to large caps points to narrowing participation in market rallies and is having a negative impact on market breadth,” note analysts at Bank of America Merrill Lynch. “NYSE and NASDAQ advance-decline lines have broken down — another sign of narrowing rallies. Other signals, such as stronger distribution (selling) volume than accumulation (buying) volume, confirm that the stock market may be in a corrective phase.”
Mr. Meisels said there is cause for some concern, but the technical readings are simply hinting that there is more room to correct before the rally resumes.
“The indicators are nowhere close to signalling any kind of bear market,” he said. “You cannot have a bear market with a rising 200-day moving average,” as is the case now for the S&P 500 and TSX.
But Mr. Meisels added that market-breadth indicators suggest there could be more downside room for the TSX compared to the S&P 500.
“The New York market is more oversold than Toronto,” he said.
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