I have been seeing analysis from various quarters raising concerns about the sustainability of the post-election stock market advance because of the poor breadth of the market. The chart below shows the NYSE A-D Line overlaid on top of the SP 500. As you can see from the chart, the NYSE A-D Line has been lagging even as the market advanced. If the generals (large caps) are leading the charge, but the troops (breadth) are not following, then such divergences are thought to be warning signs that the move may not be sustainable.
I would not be so worried about that. The NYSE Composite is made up of many closed-end bond funds and REITs which have dragged down the performance of that index. We can see a hint of that effect in TRIN (top panel). There were two days in the post-election rally when TRIN fell below 0.50, which is an indication that advancing volume was running well ahead of advancing issues. That`s because many of the declining issues were relatively thinly traded interest sensitive bond funds and REITs.
While I am not worried about a negative breadth divergence, the sudden turnaround in bullish sentiment is a concern to me.
A deeper dive into breadth
First, let me explain why breadth is not holding back the current market advance. The chart below shows several different ways of measuring breadth. The top panel shows the SP 500, along with the NYSE A-D Line (green), and the SP 500 A-D Line (red). The latter is an apples-to-apples measure of breadth as it uses the same components as the index, rather than the differing weights and components of the NYSE Composite. While the NYSE A-D Line does indicate a minor negative divergence, there is no negative divergence from the SP 500 A-D Line.
In addition, the bottom panel shows the ratio of the equal to float weight ratio of the SP 500, which is another way of measuring the market action of the “troops” and the “generals”. As the bottom panel shows, the equal vs. float weight ratio staged an upside breakout, which indicates positive breadth participation from index components.
Still not convinced? The chart below shows the various flavors of large cap, mid cap and small cap indices. With the exception of the NYSE Composite, all of the other indices are either close to a new all-time high or have broken out to ATHs.
Does this look like a picture of poor breadth to you?
What about the Zweig Breadth Thrust?
I have written about a possible Zweig Breadth Thrust momentum buy signal (see The market has spoken!). To recap, the ZBT buy signal is an (almost) sure fire buy signal which occurs when the ZBT Indicator moves off an oversold reading (which it did on November 4, 2016) and it has 10 trading days to achieve a momentum buy signal (deadline is this Friday). The problem the market faces today is that the ZBT Indicator is based on NYSE breadth, which has been weak during this advance because of the weakness of bond funds and REITs.
The chart below shows the ZBT signal (top panel), the SP 500 (second panel), the ZBT Indicator (third panel but data delayed), my estimate of the ZBT Indicator (fourth panel), and my alternative ZBT Indicator based on SP 500 breadth instead of the NYSE breadth (bottom panel). Past ZBT setups are shown with blue vertical lines and the buy signal are shown with red vertical lines.
I can make two observations from the chart. First, the past setups and buy signals from the SPX ZBT Indicator does not differ from the standard ZBT Indicator based on NYSE breadth. In the current circumstances, the better breadth internals of the non-NYSE market shows that the SPX ZBT Indicator is very close to flashing a buy signal compared to the more standard ZBT Indicator.
In fact, should the market achieve on Wednesday an advance similar to what it did today (Tuesday), we should get a SPX ZBT buy signal. But does that make it a legitimate ZBT buy signal? I don’t know, because bullish sentiment is getting a little over-stretched.
Too far too fast?
A Bloomberg report indicated that the weekly BAML funds flow report showed that clients were piling into equities at a frenetic pace. Except for private clients, all other clients were pouting money into equities, and the buying was concentrated in highly liquid large cap stocks.
Is this too much too fast? I am not sure, but here is how I would be inclined to trade the current episode. There are two scenarios to consider.
If momentum stalls and the market does not flash a ZBT signal of any form by Friday, the bull vs. bear discussion is moot. The market is probably due for a pullback.
On the other hand, should we see a SPX or regular ZBT buy signal between now and Friday, then I would interpret the funds flow report as the fast money trying to front run the slower institutional and private client flows. The market would likely pause or weaken slightly for a 2-3 days as the slower money buy into stocks while the fast money exits. Upward momentum would then likely resume as the slower but big funds flows buoy equity prices.
My inner investor is bullish and overweight equities. My inner trader is long stocks, but watching the market action closely and tightening his trailing stops.
Disclosure: Long SPXL, TNA
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