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MARKET INTERNALS

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Published 06-07-14

We attempted to "triangulate" the degree of problems we presently see within the market internals. Three distinct views suggest that urgent medical care will soon be needed for the financial markets to sustain their current levels.

WEAK BREADTH

Some pattern outcomes are blatantly obvious, especially when they are observed over longer periods of time (years) and with repeatable outcomes. Though they are often poor timing signals they are clear roadmaps for those prudent investors who don't see themselves as speculators nor traders.

ABNORMAL & UNCHARACTERITIC CORRELATIONS

FBN's JC O'Hara reports that the percent of stocks above their 200 day moving average in the S&P 500 vs the percent of stocks above their 200 day moving average for the Russell 2000 exhibits spread at their widest point in the history of his database.

Currently, the average S&P 500 stock is -5.5% below its 52 week high compared to the average Russell 2000 stock which is -20% below its 52 week high, a very large discrepancy between the two indices. The S&P 500 is at a new all times high while the average Russell 2000 stock is in a stealth bear market. Another way to measure breadth is to look at the percent of stocks above a certain moving average. This measure does a good job of compiling the bottoms up breadth of an index.

Typically, the S&P and Russell track each other closely when it comes to this measure of breadth. Taking the study one step further we measure the spread of breadth between the two indices. Looking at the percent of stocks above their 200 day moving average in the S&P 500 vs the percent of stocks above their 200 day moving average for the Russell 2000, we find the spread is at its widest point in the history of our database.

Examining the last 19 years of data we find this spread on average is ~ 7.5. The current spread is nearly 4 times as wide, registering 29.7 at yesterdays close, coming off its highest reading of 38.9 on May 14th. The chart on the previous page attempts to illustrate how the S&P 500 reacted to extreme spreads between these two breadth indicators. While we find breadth is not a proper market timing tool, a heightened reading often forewarned of troubles ahead. It was more common to alleviate a wide spread by the S&P pulling back to the Russell rather than the Russell playing catch up.

Below we list the highest points of this spread above 20 and comment on the forward reaction of the market. While it is in the Russell’s power to catch up to the S&P 500, history suggests that is not the likely outcome. Whatever path these two indices decide to take over the next few months, investors should appreciate just how different the stocks in each group are behaving. Something is abnormal and uncharacteristic of conventional markets. Breadth readings confirm that the S&P 500 and the Russell 2000 are two very different markets now.

WEAK INTERNALS

Brett Palatiello research at chapelhillresearch.com confirms the weakeness in the market internals and indicates stocks can be influenced by macroeconomic factors and be adversely affected by tightening credit conditions. The chose the following criteria to prove his point:

  • CAPE > 18
  • Utilities < 5% off 6-month high
  • Small cap stocks underperforming large cap stocks by < 5%
  • Consumer stocks < 1% off 6-month high
  • Rising Fed Funds Rate

If all of these conditions have occurred at least once in the past 3 months, a signal is given.

FINANCIALS' RELATIVE WEAKNESS

Normally at major tops the financial stocks will lead the way. The Financials will break down sooner that the other “Generals”.

Below we see the Financials versus the S&P 500 ex-financials and some very clear reversal points. Currently we have a rising S&P with the financials flat.

If you divide the financials by the S&P 500 you can see that we have a very clear breakdown. Yet another interesting signal.

 

CONCLUSION

The clock is ticking and any sort of disruptive 'event' shock could give the equity markets a heart attack based on steadily worsening market internals!

The S&P 500 is cap-weighted, which means larger companies like Apple and ExxonMobil have a much larger impact on how the index moves. High cap stocks influence the averages more thus can mask internal weakness.

The average S&P 1500 stock is down by more than 12% from their recent 52-week highs. The average stocks in the Russell 2000 and Nasdaq Composite are down by more than 20%, which means you can say they are in bear markets.

Historically, this sort of divergence does not bode well for the longevity of a market’s upward inertia. The current breadth reading is very unhealthy. Not only are new highs diminishing but many stocks are making new lows. This breadth divergence is a major concern.

This isn't necessarily a screaming sell signal. However the powerful message of “there is something wrong” should not go unnoticed".

Can anyone say "Flash Crash"?

 

 

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Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that you are encouraged to confirm the facts on your own before making important investment commitments.

© Copyright 2013 Gordon T Long. The information herein was obtained from sources which Mr. Long believes reliable, but he does not guarantee its accuracy. None of the information, advertisements, website links, or any opinions expressed constitutes a solicitation of the purchase or sale of any securities or commodities. Please note that Mr. Long may already have invested or may from time to time invest in securities that are recommended or otherwise covered on this website. Mr. Long does not intend to disclose the extent of any current holdings or future transactions with respect to any particular security. You should consider this possibility before investing in any security based upon statements and information contained in any report, post, comment or suggestions you receive from him.

 

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Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.

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