Saturday, 10 November 2012

US MARKET ANALYSIS (November 10th 2012): Prevailing Bearish Sentiment in Market Breadth

Just a quick post this weekend to highlight the technical weakness in US market breadth, which has deteriorated over the last month or so.

As we highlighted last week, leading economic indicators were broadly disappointing for the month of October. While encouraging signs were made in the recovery of US indicators, and there were some early signs of a "bottoming out" of Chinese leading indicators, the signs from Europe and Japan were cause for concern. Sure enough, this was highlighted by comments made by Mario Draghi this week, which put pressure on global equity markets.

We concluded our article last week with the following:

How does this month's data relate to our investment decisions in equity markets? While it is difficult to say where technical momentum will carry US indices, we may be more inclined to eventually buy oversold conditions in select industries, even after some disappointing PMIs this month.... There are greater apparent risks to the recovery trend than last month, especially emanating from Europe. As ever, it is worth being highly selective in entering positions, with a healthy appreciation of the risks - only adding to positions if it becomes clearer that there is positive momentum in the US economy.

I'd like to build on the statements made in that article. If we are selective with the markets and industries we wish to buy into, is now the right time to be buying on weakness before the end of the year?

While we might be inclined to eventually add risk, it is ultimately hard to decide how technical momentum will affect the entry-points we are offered as investors. One useful method is to judge the market's prevailing mood with analysis of market breadth.

For brevity, you can read more about the individual indicators and their calculation at, where these charts are taken from.


We commented on our use of the Bullish Percentage indicators in early October:

This brings us to our crossroads point in October 2012. The BPNYA hasn't made a new high in a couple of weeks, and since mid-September has been consolidating. In 2011 and earlier this year, BPNYA spent 9-10 weeks consolidating in this way - making new Dow/S&P highs in the process - before diverging from the market and falling. We will continue to watch the market breadth indicators for developments as it remains in this consolidation phase. If it begins to fall violently, diverges from the market, or continuously fails to make new highs along with the market, we will begin to take profits on long exposure.

The chart above shows how BPNYA has developed since then. The period of consolidation has been followed by a loss of momentum and eventual declines. Failure to make new higher highs in the Bullish Percentage indicators can signal a change in mood of the market. While this indicator has no regard for levels the market could fall to, we know that these indicators are reflecting a bearish mood in the main US indices.

In other words, from mid-October onwards, the bullish percentage indicators have independently given us reason to worry about a significant market sell-off. In these kind of conditions, we want to be more patient in waiting for opportunities to buy oversold markets. Like August-October 2011, it can be highly risky to buy on slight pullbacks when the market's mood is bearish.


This is a new indicator for us to discuss at Big Macro Picture. It is more volatile than the Bullish Percentage, which rely on Point & Figure analysis. It's a very simple measure - how many stocks in the S&P or the whole NYSE are above or below their 200MA? How about their 50MA? And how is that changing over time?

The trends in both charts, the % of stocks above their 200MA on the S&P and NYSE respectively, are quite clear. We can see the medium term trends in the market on a whole. From warning us out of the market in March 2011, to guiding us back in after October, the results last year were impressive. By helping us identify a weakening trend in April 2012, a difficult couple of months could have been avoided. Changing direction in June, and again in September, identifies two more turning points for the market this year.

The trend and direction of this indicator is fairly slow and deliberate, but certainly has leading qualities for the main US indices. An opportunity may eventually be afforded to the smart investor who pays attention to this indicator troughing, whenever that may be, and wherever the market is by then.

Below we have the 50MA version, which as you can imagine is far more sensitive.

As you can see, this measure looks far more erratic in candlestick form. Using the momentum indicator below can often be more useful than the 20 week MA in this case. We can see a clear early signal to re-enter the market in September 2011 - another early warning signal to reduce risk in March 2012, a re-entry signal after the weakness in June 2012, and an early signal to reduce risk again in early October.

The trends, peaks, troughs and cycles in all four charts are useful in determining underlying market sentiment. All four have deteriorated rapidly in recent weeks - we wait for signs of consolidation.


This indicator is unlike any other I tend to use, and is a cumulative calculation of advancers vs decliners over time on the NYSE. It can be a useful long term indicator, and tends to have very broad multi-year trends.

Again we can use a simple moving average (in this case 13 week MA) or a momentum indicator to define the different modes and trends in the underlying indicator. We can compare the results from other indicators to 2011 and 2012 so far. June-October 2011 is identified as a time to avoid being over-exposed to the market. October 2011 - April 2012 is identified as a "risk on" period. May 2012 is identified as a period of market weakness, but very quickly rebounds throughout the summer.

Now we see the most recent cross-over in late October, for both the TSI (bottom) and the 13 week moving average. This indicator is broad and rarely the most sensitive to react to changes in market sentiment, but recent weakness in this indicator is a cause for concern.

Another indicator, the McClellan summation index for the NYSE, is similarly used to measure the net advancers vs decliners in US stocks, and reaches very similar conclusions.

We can see this in the recent declines below the 20 week moving average, and cross-over in the True Strength Index. You can read more about these indicators here.



Finally we'll consider the NYSE Hi-Lo Index, a smoothed indicator showing trends in the number of NYSE stocks making new highs or lows. This is a particularly choppy indicator even after smoothing, so we use a slower form of TSI (40,20,10) settings, and rarely use the 20 week moving average for signals.

We can see how choppy this indicator can be - but also how market phases can be determined using the TSI. We can see how an early risk-off signal was given in April, and how the decline in NYHILO halted before the market lows in June. The TSI, having moved positive again in July, has crossed back to negative this week - inferring a very different mood in the overall market.


We have seen a variety of different market breadth indicators signalling a new prevailing mood within the stock market, beginning with the peaking of many measures of market breadth between September and October. With the advent of this week's sell off, the TSI momentum indicators have crossed over in each instance.

This shouldn't be taken as an outright signal to be net short in equities. Rather, it is an indication that we might be best served waiting before "buying weakness" in even the strongest sectors of the US market.

The analysis regarding leading indicators from last week still remains valid - the US remains the strongest main market, while Japan and Europe have particularly worrisome trends in PMI. While the US seems to be enjoying a sustained recovery from the summer's economic malaise, the above indicators show that we should be careful in our market timing.

Until we see a sustained improvement in these indicators, and with emphasis on the fragile nature of the recovery in the global economy, we'd wait before being too greedy amidst the fear prevalent in the market.

In short, "eventually buying oversold conditions" might still take a little longer. Hopefully we'll see more bullish evidence in the US economy before then.

0 responses:

Post a Comment

Twitter Delicious Facebook Digg Stumbleupon Favorites More