Saturday, October 15, 2016

Breadth Pivot Point

While the SP500 continues to trade in a volatile manner often identifying the current "trend" can be difficult. One way we can determine the overall health of the market is to watch how stocks are moving under the surface. Following the breadth of the market can be a helpful tool for trying to figure out the undercurrent of the larger trend and if/when it may be at a turning point.

I track the top 90 stocks in the SP500 as the "leaders", these tend to be the largest and strongest stocks in the world. The list I track is the from the 9 major Sector SPDR ETFs (XLF, XLY, XLK, XLI, XLE, XLB, XLP, XLV, XLU). Each group is composed of 10 top holdings. These represent the best of breed stocks in their respective industries, think J.P. Morgan, Apple, Google, Amazon, Honeywell, United Healthcare, Chevron, Bristol Meyers, etc.

I find it helpful to track these market leaders on a weekly basis to determine the overall health of the market. These stocks will begin to move ahead of the broad market averages and often hint to the next market trend. This process is not perfect but it allows us to draw a picture of the undercurrent moving the waves on the surface.

This number is tracked on a weekly basis using the price relative to the rising or declining 20 Week Moving Average. As you can imagine the stronger the trend the higher the number and vice versa. Although I will note that even in the strongest trending markets such as 2013 the highest reading from this indicator was 80. This means 80 out of the 90 stocks were trading above their rising 20 Week SMA's. The opposite is also true, when the trend is weak and stocks are breaking down.

Similar to an RSI indicator I've found that depending on the larger market type (bull market trend for example) that these breadth readings tend to trade within a range between 70+ to 30. When the trend turns negative the range shifts to 40 as resistance and 8 has been the lowest reading recorded. Which brings us to our current structure.

This week's reading came in at 30, which has proven to be support in an uptrending environment. But it also tends to be the pivot point for a healthy bull market and where conditions change dramatically into a downtrending environment. Currently we sit at an important level. Since 2013 there have been eight such readings of 30 stocks trading above the rising 20 Week SMA.

SP500 showing prior instances of 30/90 Breadth Readings 

The up arrows show where breadth hit 30 and then improved, the down arrows show where the readings were 30 then moved lower.

As you can see this tends to be a very pivotal reading. For the most part it has coincided with substantial swing points in our recent market. If I had to attach my bias on the current setup I would favor a "pullback in an uptrend" rather than an extended rollover. Of course anyone who follows me knows I've been very bullish since early spring and continue to be. Although I do note the recent deterioration in many of my longer-term holdings and am accepting to the possibility that the market can roll to the downside from here.

Something I like about this 30 breadth reading vs prior "peaks" in the price action is that the overall structure of the breadth trend is more similar to the 2014 pullbacks rather than the 2015 peaks. This 30 reading has occurred following an "overbought" 70+ breadth reading (similar to the 2014 instances) vs the 2015 readings which occurred once the breadth trend had deteriorated and never moved above the 50 level. The 2015 readings were also showing negative divergences between the SP500 price trend and the 90 Sector Stocks breadth trend.

Our current structure shows a breadth trend that reached Overbought first on June 17th 2016 and then again for three consecutive weeks from July 15th through July 29th. The current move back to 30 in breadth appears to be an overbought consolidation rather than a dying trend.

One more feather in the cap for the breath readings supporting higher prices is of the 30 stocks maintaining trend the bulk of those stocks are coming out of the Financials, Discretionary, Technology, and Energy sectors. What trends do remain are offensive in nature and suggest a rotation to more economically sensitive groups. The stocks trading in the "downtrending" group are all 10 Utility names, all Consumer Staples stocks (minus PEP), as well as MCD, WMT, KO, T, PM, MO; all stocks that are associated with high dividends and tend to be defensive in nature.

As always we need to keep an open mind, follow the signals that are presented to us (in either direction), and let the market show us the way. If we roll over from here and crash (which it seems most expect and want) then we will get stopped out of our Long positions well before the real damage is done. If we rally from here breadth readings will begin to improve soon and the uptrend will continue with the offensive groups leading the way.

Thanks for reading
-ZT

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