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VOL. 37 | NO. 38 | Friday, September 20, 2013
Time for a rally gut check
A couple of weeks ago, we discussed the lack of unanimity in the emerging markets sell-off. While the emerging markets index suggested distress within the class, a closer look revealed that only a few countries were truly under fire.
A higher conviction sell-off would have been less discriminatory. This analysis led us to believe that the selling would more than likely reverse. We posted our emerging markets opinion on Aug. 30. Since then, the emerging market index has advanced nearly 7 percent. We illustrate this not to pat ourselves on the back for making the right call, but to demonstrate that although the direction of the market matters, it’s often the conviction of the market that matters more.
Market breadth measures participation in up or down trends. Applying breadth analysis reveals whether a movement has broad support or narrow support. For example, in 1999 the S&P 500 advanced 21 percent. Great year! Unfortunately, while tech stocks nearly doubled that year, few other stocks participated. In fact, the differential between the top performing sector (tech) and the worst performing sector (utilities) eclipsed 100 percent that year. If you owned financial, health care, utility or consumer staples stocks in 1999, you most likely lost money. 1999 reads as a great year in the history books, but, in reality, it was not. Its low conviction, narrow personality unveiled itself to investors in 2000, as tech fell 40 percent and dragged the entire market down with it.
Perhaps the most widely followed measure of market breadth is the advance/decline line. This technical measure tracks the difference between the numbers of stocks advancing versus the number of stocks declining. A rising market with a rising advance/decline line conveys broad rally support. A rising market with a falling advance/decline line (a la 2007) conveys narrow rally support and underlying fragility. Applying this measure to the current market advance uncovers encouraging levels of support as volume momentum validates current levels and supports further gains. According to our advance/decline analysis, this bull has broad based support.
Another widely tracked indicator to measure the internal fortitude of an advance is the number of stocks hitting 52-week highs versus the number of stocks hitting 52-week lows. During the August sell-off, at no point did the number of 52-week lows over a trailing five-day period exceed the number of 52-week highs. This indicates that the August sell-off lacked deep conviction. Currently, the number of stocks hitting new highs well exceeds the number of stocks hitting new lows. The high-low analysis also depicts broad based support.
Unfortunately, broad based sponsorship does not itself preclude painful sell-offs. However, a market with a strong core, as this one has, needs a pretty strong gut punch to topple over. That gut punch could come from the Fed, Syria or the impending debt debate. Yet these threats alone do not have enough power to stem the upward bias. Forward expectations at the moment favor the bulls; for the bears to gain control of this market, they will need more than fear-mongering.
David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.