Domestic large-cap stock indexes continue to rise – the S&P 500, Dow Jones Industrials, and Nasdaq all reached new highs earlier this week. Their strength masks a lack of progress made by the majority of stocks over the last few months. In other words, breadth stinks.
The concept of breadth is pretty simple: the more stocks that participate in a trend, the stronger that trend is. A handful of large stocks can drive cap-weighted index prices higher by themselves. Sometimes they can do it for longer than most people expect. But they can’t do it forever. Monitoring stock market participation is one way to monitor the health of a trend.
The cumulative advance-decline line might be the most well-known of breadth indicators. Its calculation is fairly simple: an index is created by cumulatively adding or subtracting the net of rising vs. falling issues for each trading day. If a greater number of stocks are rising than falling, the advance-decline line rises, and vice versa. No indicator is infallible, but the NYSE Advance-Decline line has diverged from prices before several major stock market selloffs. It’s sending a cautionary signal now, falling over the last 2 months while the S&P 500 has continued to rise.
Equal-weight stock indexes confirm a lack of participation. The S&P 500 is a market capitalization-weighted indexes – the largest companies have the largest weight. Giving each stock the same level of importance, regardless of size, results in an index that’s been flat since May.
Small and Mid-cap stocks aren’t playing along either. The Russell 2000 peaked in March. Mid caps did so in April.
One of Dow Theory’s most popular tenants is that Transports should confirm higher prices in stocks, but they haven’t. They’ve been falling for a few months. Some argue that the world has changed – Railroad and Trucking companies don’t have the same importance in a digital world. Perhaps they’re right. But Semiconductors, the industry most commonly substituted for Transports in a so-called “New Dow Theory”, have been flat since February. In either case, new highs for the headline indices are still waiting for a thumbs-up from Mr. Dow.
It may look like I’m just pasting the same chart over and over again, but I’m not. International stocks are struggling to set new highs, too. Emerging Markets have been especially weak, and just broke to six month lows.
Beneath the surface of the S&P 500’s new highs lies Turmoil. Sixty percent of industries have lagged the index over the last 3 months, and individual stocks are struggling to maintain their uptrends. Only half of the 500 are hanging above their 50-day moving average, with offensive sectors struggling the most.
Breadth over the last few months just hasn’t been good, and in the past, weak breadth has often led to corrections and even bear markets. That said, almost 90% of stocks are still above their long-term moving averages – they aren’t yet in downtrends, they just aren’t moving higher. If more stocks start breaking to new lows, there could be trouble, but unless that happens, we’ll leave it at this:
New all-time highs aren’t bearish, but without participation of a majority of stocks, it’ll be a lot tougher for the indexes to keep moving higher.
Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.
The battle between Growth and Value stocks has raged for most of the last year. Growth dominated the early stages of the COVID recovery, but in September last year, a Technology-led selloff brought Value into the limelight. Since then, the S&P 500 has continued higher in seemingly steady fashion. Underneath the surface, though, it’s been anything but steady.
There’s been a distinct rotation between the Growth and Value trades – one group leads for a few weeks, then lags for a few. And back and forth it’s gone:
Growth and Value have traded punches, but no clear winner emerged – they’re fairly even since mid-September. The loser has been obvious. The Safety trade, especially the Utilities and Consumer Staples sectors, lagged in dramatic fashion.
That wasn’t the case last week. For the 7 days ending July 16, Utilities were up 2.55% and Consumer Staples gained 1.25%, performances that led U.S. equities. It’s the first time those sectors have nabbed the top two spots for a week since March 6, 2020.
The relationship between the Safety sectors and the S&P 500 is a helpful gage for risk appetite. Risk-seeking investors avoid these ‘boring’ sectors, while risk-averse investors favor them. Thus when stock prices are rising and risk appetite is strong, Utilities and Staples tend to decline relative to the S&P 500 Index, and vice versa.
Accordingly, during the early days of the pandemic, risk-averse investors drove Utilities and Staples to multi-year highs vs. the broader index. Contrarily, the two fell sharply behind during the subsequent recovery.
It looked like Safety might end its relative decline after forming a low in February. Utilities and Staples both kept pace over the following months – their prices relative to the S&P 500 moved sideways, rather than down. But when Growth resumed its leadership role in June, Safety dropped through its February lows.
Their relative strength last week pushed each Utilities and Staples back above those February lows.
The relative trend in these two sectors is still down – price is well below a falling long-term moving average. That said, ‘false breakdowns’ like this often set the stage for reversions to the mean (or trend reversals). Given their broader implications for investors’ risk appetites, keep an eye on these ratios in the weeks ahead.
Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.
The second quarter of 2021 has come to a close, and that means another round of earnings reports is about to start. Earnings are an important component in a weight-of-the-evidence based approach to investing. For one, remember that buying a stock is taking an ownership share in a company and its profits. At the end of the day, we’re buying earnings. Second, from a more tactical perspective, earnings are a helpful reflection of current economic activity. And finally, they’re an important input into valuation multiples. As we enter the Q2 earnings season, expectations are elevated, to say the least.
Below is a chart of S&P 500 aggregate operating earnings per share – both the forward 12-month consensus estimate (red), and actual trailing 4 quarter sum (blue). The pandemic slammed earnings expectations early last year, causing a rapid fall of ~25% in forward EPS. But just as quickly as estimates fell, they rebounded. By the end of 2020, forward EPS was nearly back to pre-COVID levels, and 6 months later it’s solidly in new high territory.
The translation to actual earnings was a decline of about 14% in 2020, the worst drop since the financial crisis more than a decade ago. Should actual earnings live up to current expectations, though, it will mean a 35% rebound in 2021, followed by another year of double digit growth in 2022. Given the long-term average growth rate of earnings is only about 7%, those are pretty robust estimates.
Hefty growth expectations are reflected in valuations. The S&P 500 forward P/E ratio is hovering near the highest levels since 2000. Equity index valuations are subject to a variety of factors, including interest rates, sector weights, and general risk appetite, but at nearly 22x forward earnings per share, this multiple certainly contains some degree of expectation that growth will be above its historical trend for a few years.
For its part, business is living up to expectations thus far. According to FactSet, a record 59 companies issued positive guidance ahead of their Q1 EPS reports. Sixty-six have issued positive guidance for Q2, leading to a 7.3% increase in earnings estimates over the last 3 month. That’s higher even than the first quarter of 2018, which benefited from a last-minute cut to the corporate tax rate.
Whether earnings can continue to meet and exceed heightened expectations will likely depend on margins. Revenues seem to be in a good place – they track economic activity even more closely than earnings, and economic activity is still recovering at a healthy pace. Historically, year-over-year revenue growth has tracked pretty well with the Institute for Supply Management’s measure of Manufacturing PMIs (below). With PMIs up near their best levels of the last 30 years, it’s hard to be overly concerned about the trajectory of revenue growth, barring a domestic virus resurgence. Additional fiscal stimulus could even lead to an upside surprise.
There’s significantly more uncertainty surrounding costs and profit margins. Inflation continues to be front of mind for both management teams and the analysts that cover their companies. Almost 40% of S&P 500 companies cited the word ‘inflation’ during earnings conference calls, and dozens more used alternate phrases to express worrisome cost and price dynamics.
Between breathtaking increases in commodity prices, rising freight costs, semiconductor shortages, a lack of qualified labor, and ongoing tariff disputes that further disrupt supply chains, businesses face a myriad of issues that could cause them to fall short of earnings projections. The pace of global re-openings and the labor market recovery will be both bear watching in the months ahead.
Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.
Six months ago on Means to a Trend, we took a look at the Growth vs. Value ratio and discussed a potential end to Growth’s decade of dynastic dominance. Value had shown signs of relative strength in the preceding months, and it was all taking place near a key extension from the dotcom collapse.
Value’s run continued in early 2021, with the SVX Index outperforming SGX by more than 10% by early March. In December, we noted that a long-term reversal in the ratio would require the Financials sector to lead, which most likely meant they need to be above their 2007 highs. The Financials did not disappoint.
Absolute performance hasn’t mattered of late, though. The ratio of Financials vs. the S&P 500 failed at resistance and is stumbling.
Last week, value stocks lagged growth by 2%. So was it just a tough week? Or did Value’s long-awaited day in the sun come to a premature end? Here are a few other things to consider.
The SGV/SVX ratio mentioned at the onset of this post is still below resistance from earlier this year. On the other hand, momentum improved, and Growth set a higher low relative to Value on the most recent pullback.
Industrials, a sector that’s been important to value’s outperformance, hasn’t surpassed relative resistance from its early-2020 breakdown. Similarly to the relative strength of Financials, above, momentum failed to confirm the most recent swing high, and prices took a hit last week.
Interest rates just fell to multi-month lows, too. Lower borrowing spreads tend to be bad news for Financial stocks, while lower rates disproportionately benefit valuations for faster growing businesses. Both are headwinds for the relative value trade.
From a longer-term perspective, those same yields are still holding decade-long support. It could be that we just needed further consolidation before rates (and the value trade) resume their march higher.
It remains to be seen whether last fall really was the bottom for Value, or just a bottom before the long-term trend resumes. If it was the bottom, last week’s pain will be forgotten soon enough.
Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.
The S&P 500 Energy Sector led U.S. stocks in May and again the first week of June. Up 47% since the end of the year, it’s the top sector so far in 2020. The rally puts the group at new 52-week highs and above significant resistance formed by bottoms in 2016, 2018, and 2019.
On a relative basis, Energy has been in a long-term downtrend since 2008, with the most recent low set in the fall of 2020. By this measure, the sector is still below its March peak, but, importantly, prices are breaking above a 3-year downtrend line for the first time.
As a reversal indicator, trendlines have a mixed record – a trendline break is not an infallible sign of a trend change. At the same time, you can’t have a trend change without breaking trendlines. In this instance, the case for a new relative uptrend in Energy stocks (as opposed to a mean reversion within an ongoing downtrend) is strengthened by a textbook momentum divergence at the 2020 lows.
Confirming – and contributing to – the recent strength in Energy is oil’s continued surge. The price of WTI reached the highest level since 2018 last week, thanks to a widening supply/demand imbalance as the global recovery continues.
In May, the International Energy Agency adjusted its consumption outlook for the coming years: it now expects global demand for crude oil will return to pre-COVID levels sometime next year, as opposed to the prior estimate of 2023. Meanwhile, OPEC and its allies have flexed their mighty muscles over the last 12 months, keeping global inventories largely in check through an array of voluntary production cuts. Even as they bring capacity back online this summer, OPEC expects demand to exceed global supply well into the second half of the year – whether Iran manages to garner sanctions relief or not.
In the decade past, it seemed at times that OPEC’s grip on the world’s oil market was slipping. That’s because innovations in U.S. shale regions made domestic crude oil cheaper and more plentiful than ever. Even after crude prices peaked in 2014, U.S. production continued to rise and was setting new highs just before the pandemic. But the ensuing crisis hardened the resolve of those who’ve long sought to instill discipline on shale drillers. U.S. oil executives are now increasingly focused on maximizing cash flow and capital return, not taking on debt to maximize output, so even though oil prices have fully recovered, production hasn’t budged:
They say the cure for high commodity prices is high commodity prices. If crude oil continues its march higher, we’ll get to see just how ‘disciplined’ all these producers really are.
Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.
Inflation. It’s been dead in America since the 90s, yet a recent surge in prices has brought it back into focus. You’ve heard the word, seen the headlines, perhaps even lived through the domestic edition in the 1970s, but what exactly is it? There seems to be some disagreement.
The first recorded use of the word ‘inflation’ with respect to economics was in 1838, by American politician Daniel D. Barnard in a speech to the Assembly of New York. In it, Barnard requested two amendments to the General Banking Law under debate, each aimed at guarding against the depreciation of paper notes. The first was that banks be required to limit outstanding currency issues to five times the amount of specie on hand, and the second, that all currency notes be redeemable at par in the city of New York. The key provision in the bill that concerned him stipulated that redeemable notes issued by banks would be backed by property in the event that specie (e.g. gold or silver) could not be provided by the bank within 24 hours. Barnard, familiar with the sad history of property-backed currencies, said bluntly,
“In the first place, the property pledge can have no tendency whatever to prevent an inflation of the currency, which is always a point of danger”
Daniel D. Barnard, Speeches and Reports in the Assembly of New York at the Annual Session of 1838
Barnard’s use of the word may have been new, but the concept wasn’t. Adam Smith, the father of modern economics, was familiar enough with the idea that he took care to differentiate between “real” and “nominal” prices in his 1776 book Wealth of Nations. Hundreds of years later, though, academics still don’t fully understand it. They’ve even struggled to settle on a definition. In a piece titled “On the Origin and Evolution of the Word Inflation” published by the Federal Reserve Bank of Cleveland in 1997, the confusion was summarized this way:
“Today, we commonly hear about different kinds of inflation. Indeed, the word inflation is often used synonymously with “price increase.” But there is also a different, more specific, definition of inflation – a rise in the general price level caused by an imbalance between the quantity of money and trade needs… It is the latter definition… that more closely conforms with the word’s original meaning.”
Michael F. Bryan, current Vice President and Senior Economist at Federal Reserve Bank of Atlanta
Bryan’s words, already more than 20 years old, ring ever true today. Inflation measures are on the rise, and a debate rages. One side argues that readings this year are a result of one-time and temporary price increases related to the pandemic, and therefore aren’t indicative of true inflation. The opposing side points to the extraordinary amount of fiscal and monetary stimulus unleashed in the last year as the primary cause of rising prices. This latter form of inflation, the one Barnard feared, tends to end in disaster.
In 18th century France, an over-issuance of paper assignats (in an effort to stimulate a debt-laden economy) caused their value to plummet and helped spur a bloody revolution. In the 1920s, Germany’s Weimar Republic dealt with perhaps the most famous hyperinflationary period in history as it tried to repay war debts. Hungary, too, tried extreme fiscal stimulus to spur the post-WWII recovery, but capacity was slow to return, and the effort resulted in the worst hyperinflation in recorded history. The last 100 years are riddled with similar bouts of rapidly rising prices – in the Soviet Union, Argentina, Yugoslavia, Zaire, Zimbabwe, Russia, Venezuela, and elsewhere – with varying degrees of disastrous outcomes.
So if inflation so regularly ends in disaster, it would seem that rising prices in any form should be anathema to central banks. But that oversimplifies the issue. Some inflation actually works to stimulate growth. Indebted asset owners benefit from higher prices, while cash is guaranteed to lose value. Thus, inflation stimulates borrowing (you get to pay back loans with cheaper dollars in the future) and incentivizes spending (you should buy something now instead of when the nominal price is higher next year). Increased spending is what makes the proverbial economic world turn round. Those incentives start to disappear when inflation rises too quickly and becomes unpredictable. What person wants to take on debt or spend aggressively when their future cost of living is uncertain? Likewise, businesses are apt to take a more cautious approach to capital expenditure decisions, or pull back altogether. Consequently the world’s most powerful monetary authorities want inflation that’s predictable and low.
Just not too low.
In the same way that inflation incentivizes spending and credit creation, deflation incentivizes saving over spending. While generally advisable for an individual’s financial health, reduced spending and excess saving on a macro level weighs on economic growth. To both foster full employment and maintain price stability, the Federal Reserve works to thread the needle between inflation that is too high and too low.
Unfortunately for them, many drivers of inflation are outside their control. Inflation may be a monetary phenomenon, but it’s not solely a monetary phenomenon – just ask the Bank of Japan, who’s (rather unsuccessfully) fought deflation for the last 25 years and has used unprecedented policy tools like negative interest rates and direct equity purchases to try stimulating growth. Economist Ed Yardeni details four D’s in this excerpt from his book, Fed Watching for Fun & Profit, to explain global deflationary forces in place since the turn of the century. Here’s a quick summary:
Détente (Globalization) – War is inflationary. Peace is deflationary. Since the end of the Cold War (and with the addition of China to the WTO) global trade barriers have fallen. Inflation has been pushed lower by worldwide competitive forces.
Demographics – The world is aging. Older people tend to spend less than their younger counterparts, and younger people today tend to spend less than previous generations. Relatively lower demand, coupled with the rising labor market share of more experienced and productive workers, has exerted downward pressure on prices.
Disruption – Rapid technological innovation over the last 25 years has enabled businesses to cut costs and boost productivity across a wide range of industries.
Debt – A generation of low interest rates has resulted in elevated levels of debt. Consumers are effectively ‘maxed-out’, limiting new spending. Additionally, easy money conditions are supportive to production capacity, boosting supply and driving prices lower.
Enter a global pandemic. Governments around the world shuttered economic activity in an effort to limit the spread of COVID-19, then unleashed never before seen levels of fiscal and monetary stimulus. In the United States alone, fiscal measures enacted since last February sum to more than $5 trillion dollars – almost a quarter of pre-pandemic GDP. There’s roughly $4 trillion more on deck if Congress agrees to the proposed American Jobs and American Families plans. The Federal Reserve was not to be outdone. They cut short-term interest rates to 0%, doubled the size of their balance sheet to almost $8 trillion, and continue to buy $120 billion of Treasuries and mortgage-backed securities every month.
By and large, the stimulus worked as intended. Thousands of businesses were able to access cheap credit and stay afloat. Millions of workers lost their jobs, but direct checks and enhanced unemployment benefits were so substantial that aggregate U.S. personal income jumped a record amount to reach new highs. As a result, consumer balance sheets are abnormally healthy.
All that extra cash helped spark a buying spree. Unable to spend on traditional services thanks to lockdowns, consumers turned their eyes to goods – furniture, vehicles, homes, toys, groceries. The only problem? Supply chains (some still even under lockdown) weren’t ready for so much demand. The price of construction materials has soared, with copper and lumber leading the way. A global shortage of semiconductors has forced automakers and other manufacturers to halt or slow production, sending new and used car prices through the roof. Median home values are rising at a double-digit pace. Grain prices reached the highest levels since 2013. All told, the April reading for the core Consumer Price Index rose at the fastest pace since 1996.
In normal times, that might have triggered concern for the Federal Reserve and their price stability mandate, but Chairman Powell has spent the better part of the last 6 months warning that any increase in CPI this year would be ‘transitory’. He’s blamed the base-effect – abnormally low measures from a year ago – and the temporary nature of supply chain disruptions for elevated price increases. Federal Reserve economists have taken a unified stance that inflation will fall back toward their 2% annual target by year-end, when global activity has more fully recovered.
A few economists disagree, perhaps none more vocal than former Treasury Secretary Larry Summers. Summers has warned that additional stimulus in 2021 was largely unnecessary, even irresponsible. He’s concerned – especially after the latest CPI data – that inflation could spin out of the Fed’s control, leading to stagflation or a monetary policy clampdown that results in recession. In rebuttal to those pointing to labor market slack, Summers notes that enhanced unemployment benefits could be decreasing labor supply, and the labor market is tighter than data suggests. If he’s right, it could send wages and prices into an upward spiral.
The future may well depend on businesses’ willingness to protect margins and raise prices – and consumers’ willingness to pay them. We’ve been carefully tracking inflation-linked commentary from company executives over the last three quarters, and it seems we’re not the only ones. According to FactSet, the term “inflation” has been used on more earnings calls this quarter than in any period since at least 2010.
More important than the number of mentions is the change in tone about pricing since the fall. As one extreme example, consider the homebuilding industry. Ryan Marshall, CEO of PulteGroup, said this about pricing in October:
“It is important that we not become overly aggressive and move prices too fast or too high, particularly within first-time communities. Given market competition and normal affordability constraints among entry level buyers, pushing prices a few thousand dollars too high can stall sales very quickly”
Ryan Marshall, President and CEO, PulteGroup Inc.
Afraid of stifling demand, affordability was cited 7 times on that conference call. During the most recent call in April, it wasn’t mentioned once. The focus shifted instead towards driving price increases and boosting (not just protecting, but boosting) margins. Here’s their Chief Financial Officer:
“While we now expect our house costs, excluding land, to be up 6% to 8% for the year, the strong demand environment is allowing us to pass through these costs in the form of both higher base sales prices and lower discounts. Given these cost/price dynamics, we expect gross margins to move higher throughout the remainder of 2021.
Robert O’Shaughnessy, CFO, PulteGroup Inc.
For the consumers’ part, such aggressive price increases haven’t been enough to crimp demand. PulteGroup, along with peers, has resorted instead to limiting lot releases to shorten backlog lead-times. The dynamic isn’t limited to homebuilders. From labor, to commodities, to packaging materials, to transportation, input costs are on the rise. And from personal care products, to water heaters, to frozen chicken, to new cars, consumer prices are rising. Nonetheless, consumers are still spending. The most recent retail sales report may have been below expectations, but the 17.9% increase from pre-COVID levels was still the fastest 14-month growth rate on record per available U.S. Census Bureau sales data.
The big question is, how long can the supply/demand imbalance last? Supply chains are still woefully behind, but how quickly can production capacity be brought online? Enhanced unemployment benefits expire in September – how might that impact incomes, spending, and labor costs? How long will it take to burn through the excess savings generated during the pandemic? Will the Fed take its foot off the gas? Will Congress further stimulate demand with fiscal measures? And even if they do, is that enough to offset Yardeni’s four D’s?
We’ll have some answers in the coming months. Until then, Powell, Summers, and their respective supporters are sure to have some lively debates.
Prices are definitely rising. Is it inflation? Or inflation?
Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.
If you look across the globe, it’s not hard to find stocks setting new highs. That’s especially true in Europe, where several of the largest indexes are in strong uptrends. The German DAX has more than recovered from its pandemic selloff and hovers near its record.
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Likewise, the benchmark French index finally surpassed its 2007 peak, and closed at a 20 year high on Friday.
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You’ll find similar stories in the Netherlands, Switzerland, Norway, and Denmark.
Even Italy, whose economic health and government’s solvency have been in question for the better part of the last 15 years, is enjoying equity prices near breakout levels. The FTSE MIB hasn’t held above 25,000 for more than a decade.
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Given so much internal strength, it’s no surprise to see the STOXX Europe 600 at new highs, too. The COVID collapse pushed prices back below 20-year resistance near 400, but now that level finds itself in the rearview mirror once again.
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Unfortunately, none of that matters. Europe may be setting new highs, but as far as U.S. investors are concerned, it’s still near its lows. Relative to the S&P 500 Index, the STOXX 600 (priced in USD) is mired in a long-term downtrend. The all-time low was set last fall, but after a rally in late 2020, the trend so far in 2021 has been less than inspiring.
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If that trend is to change, it’ll likely need help from sector rotation. Europe’s relatively lower exposure to Technology stocks is largely to blame for its underperformance in recent years. Conversely, a long-term shift from growth to value oriented stocks – which may have started last fall – would favor European indexes.
Keep an eye on the U.S. Dollar, too. After Friday’s dismal non-farm payrolls report (266,000 jobs added in April vs. 1,000,000 expected) the Dollar Index had its worst day in months.
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It’ll take more than one bad data release to reverse a multi-year downtrend in relative prices. But a value recovery paired with continued weakness in the USD might be just what’s needed to make European equity investments worthwhile again.
Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.
The S&P 500 set another intraday record last week. I started this blog 2 years ago with the intention of helping readers identify market trends, but when the foremost equity index keeps hitting new all-time highs, the readers don’t really need my help. The trend is higher. Clearly. And if market breadth is any indication, that trend is in healthy condition.
The concept of breadth is pretty simple: the more stocks that participate in a trend, the stronger that trend is. The cumulative advance-decline line might be the most well-known such indicator. Its calculation is easily understood (the difference between rising issues and falling issues at the close is added to the previous day’s value), and it has reliably diverged before several major market declines. Most recently, the NYSE Advance-Decline line failed to confirm new highs in February 2020, foreshadowing the March collapse in prices. Things are different today. The A/D line is setting new highs right along with the S&P 500.
The vast majority of stocks are in uptrends, too. The 200-day moving average is a simple (though not infallible) tool to gauge the trend of prices – if the current price is above the 200DMA, a stock is generally considered to be in a long-term uptrend. At the very least, it’s hard to argue that a stock trading above its moving average is in a downtrend. With that as our backdrop, few stocks today are in downtrends. In fact, more stocks in the S&P 500 are above their 200DMA than at any time in the last 30 years (the extent of my available data).
With so many stocks in uptrends, it should come as no surprise that many are setting new 52 week highs as well. And almost none are setting new lows. If trends were weakening, we might see the number of new highs diverge from prices like they did in February 2020 before the selloff began. But that’s not what we’re seeing today.
Stock prices are moving higher. That trend could stay intact for another year or it could change tomorrow. Who knows? No matter the market environment, if you look hard enough for signs of trouble, you can find a reason to be concerned. Right now, market breadth isn’t one of them.
Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.
The relative strength index (RSI) is a momentum oscillator created by J. Welles Wilder Jr. that measures the speed and magnitude of recent price changes. One of the most common interpretations of RSI is that a reading greater than 70 (on a scale of 0 to 100) indicates ‘overbought’ levels, signaling prices may be primed for a pullback. A reading below 30, on the other hand, is called ‘oversold’, and hints at a possible bounce. This simple interpretation has a mixed historical record for timing reversals – overbought readings can get even more overbought, and vice versa. When calculated using a 14-day period, though, RSI can provide valuable information about the volatility of future returns.
Stock market forecasters face a persistent problem with historical data: There isn’t enough of it. For many factors used to make forecasts in the today’s world – economic data, book values, earnings, etc. – data wasn’t rigorously collected until the 1950s and 1960s. Academics have made valiant efforts to compile information from before then, but that information is subject to survivorship bias and bookkeeping flaws. Luckily, RSI skirts those issues, because RSI is a direct transformation of price data, which has been collected for much longer.
Charlie Dow was the first (or perhaps only the most famous) to aggregate and publish prices for a U.S. stock index. Thanks to his efforts, daily prices for his trademark Industrial Average are available as far back as the late 1800s. A review of that data shows that RSI exhibits a strong negative correlation with the standard deviation of future return distributions.
What’s striking about the data is not only the strong relationship, but the consistency. No indicator is perfect, and even widely used factors fall out of favor for extended periods. This relationship, though, managed to hold consistently over rolling 10 year periods since 1900, especially over 1 week and 1 month horizons. And while RSI’s predictive value for volatility clearly declines with time, it still offers insights into returns as far as 2 years in the future.
Moreover, it’s held not just for the Dow Jones Industrial Average, but for the S&P 500 and the Nasdaq Composite, too.
Momentum is nearing extremes for some of the major indexes today. But when prices are ‘overbought’ or ‘oversold’, think less about what that means for the direction of the market and more about what it could mean for volatility.
Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.
It’s been more than 6 months since Tech stocks peaked relative to the market. In the nearly two years prior to last September, the Information Technology sector – and especially its large components – were the darlings of Wall Street. Throughout the turbulence of trade wars and uncertainty of a pandemic, it seemed these leaders couldn’t be stopped.
For some, the dominance might have been reminiscent of another certain tech-fueled rally, one that ended in dramatic fashion at the turn of the century. It’s fitting, then, that this most recent rally stopped at the same place it did more than two decades ago.
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The theories behind support and resistance in technical analysis are grounded in investor psychology. In a simplified scenario, consider someone who owns a stock that trades to a high of $20 per share. The price subsequently falls to $10. The owner, disappointed with the depressed value of his investment, wishes he had sold at the high price of $20. When the stock finally recovers to $20, the investor, remembering the feeling of loss when prices were at their low of $10, thankfully sells his shares for the previous high price of $20. The shares he is willing to supply at that price (and the shares of other investors with a similar experience) create ‘resistance’ – a price level that is difficult to break above.
Alternatively, consider another investor that monitored, but did not own, the same stock. He watched as prices fell from $20 to $10, and then rose back to $20. Seeing the high price, he wishes he’d had the courage to buy when prices were much lower. When the price falls back to $10, he thanks his lucky stars for the second chance and buys the stock. His demand for shares (and the demand of other investors dealing with the same emotions) creates ‘support’ – a price level that is difficult to break below.
Whether you believe those two scenarios are accurate representations of investors’ emotions and actions is neither here nor there. What’s most important is that support and resistance are real. It’s not mere coincidence that Information Technology stocks stopped outperforming at exactly the same spot that they did in 2000. Prices have memory. And until Tech can absorb the overhead supply created by the Dotcom bubble, they won’t be leading this market higher. Here’s a closer look at the recent price action:
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Relative to the S&P 500 Index, Tech has moved sideways since the September 1st peak. Swing lows from later in September had provided support in October, November, and again in January, but the selloff in early March pushed the ratio to new lows. Additionally, it drove prices below the 200-day moving average for the first time in 2 years and sent momentum into oversold territory for the first time since 2017. In the weeks since, not much has changed. Bulls have yet to regain control, but the bears have been unable to capitalize on the breakdown by pushing prices even lower.
Value stocks are back in vogue these days, and could stay in the spotlight with this ratio stuck in consolidation mode. Sideways action is healthy after long uptrends. But watch carefully for a resolution. If it turns lower, stocks overall could be under pressure. But if Tech surpasses the Dotcom highs, Value’s stardom could be short-lived.
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