/ June 24 / Weekly Preview
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Monday:
N/A
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Tuesday:
S&P/Case-Shiller Home Price YoY (6.9% exp.)
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Wednesday:
New Home Sales (0.64M exp.)
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Thursday:
Durable Goods Orders MoM (0% exp.)
Q1 GDP Growth Rate QoQ Final (1.3% exp.)
Initial Jobless Claims (236K exp.)
Pending Home Sales YoY (2.5% exp.)
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Friday:
Core PCE Price Index MoM (0.1% exp.)
Personal Income MoM (0.4% exp.)
Personal Spending MoM (0.3% exp.)
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Monday:
N/A
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Tuesday:
FedEx FDX
Progress Software PRGS
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Wednesday:
Micron Technology MU
General Mills GIS
Paychex PAYX
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Thursday:
McCormick & Company MKC
Nike NKE
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Friday:
N/A
“Markets are strongest when broad and weakest when narrow.”
We’ve been discussing a technical issue plaguing the latest advance of the equity markets for a while now - bad participation (or breadth) has only gotten worse in the past week. But what does breadth exactly mean and why does it matter for our investing decisions?
Simply put, market breadth measures certain key performance metrics related to most stocks on a given exchange. Originally, the major indexes (S&P 500, Nasdaq) served the purpose of quickly informing investors about the “average” performance of the stock market. However, due to the popularity of passive investing and low cost index-tracking ETFs, these indices have lost their ability to correctly relay meaningful information about the underlying market. At the moment, passive funds hold more assets under management than active funds.
This creates a completely different and distorted market dynamic, similar to a “tail wagging the dog”.
A short history lesson: 50 years ago, capital was actively allocated by fund managers, each with his own style and preference for industry and risk. These managers would reward the stocks of companies which were growing revenues and EPS, and conversely punish the stocks of companies unable to deliver results. Major indices were there to provide a neutral benchmark for these managers to compare against - but there was no way to directly invest in indices. However, in 1976, everything changed due to John Bogle’s groundbreaking idea of launching a different kind of fund: the Vanguard 500 Index Fund, specifically designed to track the performance of the S&P 500.
Bogle's proposal and endorsement of the S&P 500 as a better investment option than actively managed funds stemmed from his belief in the efficiency of the market and the advantages of low-cost, passive investing. He consistently argued that over the long term, most actively managed funds would underperform the market due to higher fees. For the most part he was right. Which brings us to today’s market.
In 2024, it’s the indices which dictate where capital gets allocated, not the other way around. Companies get rewarded simply for being a part of this popular investment style. The larger a company is, the more it is being rewarded, in cap weighted indices (which are most popular). In practical terms…
MOST INVESTORS
ARE
HOLDING
THE
SAME
STOCKS.
Which, in turn, means that the S&P 500 and similar indices are starting to egregiously diverge from their original intention of informing investors about “average” stock market performance. In today’s newsletter, we’ll challenge our readers to practice a thought exercise. What if there was no S&P 500? No average index? How would one know if the market is doing well or not? Most likely, investors would retort to a market breadth measurement.
A classic such indicator is the Advance / Decline line, cumulating the number of advancing stocks (those that closed higher than their previous close) to the number of declining stocks (those that closed lower than their previous close) on a given day. Running this analysis on the Russell 3000 index (comprising 96% of the investible market), you would get this chart:
Breadth as measured by the A/D line on the whole market is not far from the April lows, when a -5% correction was in the works.
A more momentum focused approach to breadth measurement would count the number of stocks trading above their 50-Day Moving Averages. One would expect a majority of stocks to close above the 50-Day Average in a bull market. In our system, the count only applies to the top 1000 stocks by dollar transaction volume, but the result is telling nonetheless. 2024 started on a high note, with a record number of stocks closing above their 50-DMAs, but momentum was progressively lost throughout the year.
Currently only about half of the top 1000 stocks are maintaining this key technical level.
For the same top 1000 stocks, we could also compute the average Z-Score (distance from mean regression line, measured in standard deviations). A similar picture emerges, whereby the average stock is now sitting right at the middle of its trading channel - the latest average score is +0.05, down from +0.73 at the end of 2023.
This measure is not far from previous lows encountered in October 2023 (-0.39) and March 2023 (-0.26).
Another way to visualize market breadth without directly referencing any index is by comparing the performance of the Equally Weighted S&P500 (RSP) to the market cap weighted ETF (SPY). This ratio has been trending lower for the past 2 years and it appeared to be stabilizing for the better part of 2024. Starting in late May, this ratio tanked aggressively to new lows. As shown, the spread in performance between the SPY and RSP is at the highest level since the “Pandemic”.
Sentimentrader recently provided a suitable conclusion to our analysis:
“Technically, the best thing that stocks have going for them is momentum. When it reaches the level it’s at, it becomes a powerful force that can continue for weeks or more.
There is significant deterioration under the surface of this momentum, so it’s on a shaky foundation and is more likely to fail than if there were more supports. By the time it gets to this stage, we’re usually at the “weeks, not months” part of the cycle. It doesn’t say much about prospects for longer-term investors, but those with a more medium time frame should be on guard.
When gains get this easy, it’s usually about to become much less so.”
And, of course, we have to mention Bob Farrell’s saying which also inspired the title of this article:
“Markets are strongest when broad and weakest when narrow.”
The trading calendar is light this week on the conference call side, with Nike (NKE) wrapping up Q1 earnings season on Thursday. The key day to watch for economic reports will be Friday, when the Core PCE Price Index is released, along with Personal Income and Spending.
The Core PCE Price Index is the Federal Reserve’s preferred gauge to measure inflation and is expected to decelerate to +0.1% from +0.2% in April. It will be interesting to watch how small caps react to this data on Friday.
Our Trading Strategy
This week, we have purposefully excluded a technical analysis of the SPY ETF, in order to challenge our readers to “detach” from what the media tells them is “the market”. If there was no such thing as a benchmark index and you could only rely on internal metrics for the stock market, how would you decide to invest? Would you think this was a roaring bull market? What about the average performance of a stock in 2024? (it’s about +5% so far).
While having an established and trusted process for investing is key, sometimes shaking things up and looking at the market with “fresh eyes” may lend a different perspective. In our case, the only reason to remain bullish currently is the ongoing momentum is mega cap names and technical support at the index level.
The broad market is clearly consolidating, making life difficult for any stock picker. For now, we expect volatility to slightly increase, as there is simply too much complacence among investors. The market’s advance is getting ever more narrower, to the point it’s hard to really call the S&P 500 “the market”.
While bad breadth in and of itself is not indicative of an impending “crash” or “correction”, it is certainly not an encouraging signal. Constant new highs at the index level have a tendency to translate into further new highs. Momentum-driven markets can last longer and go further than anyone can predict. However, as a part of healthy risk management, we are holding back on adding further equity risk exposure at the moment. Whenever a turn in performance occurs, we’ll be ready to take defensive action.
Signal Sigma PRO members will be notified by Trade Alert of any live portfolio changes (if subscribed). If you’re not on this plan yet, you can get a free trial when you join our Society Forum. If you need any help with your trading strategy (or would like to implement one on your account), feel free to reach out!