The Russell 3000, a broad equity index representing 98% of the investable U.S. stock market, is up 9.3% for 2014 on a total-return basis…[but] the median total return for Russell 3000 constituents is just 1.5% reflecting the fact that small- and mid-cap stocks are under-performing… This current alarming deterioration in breadth, a term that refers to how much of the market is participating in the advance, begs the question: “Is the stock market sitting on a trap door?” This article looks at 2 trap door indicators that suggest that that might, indeed, be the case.
The above introductory comments are edited excerpts from an article* by Alan Gula, CFA (wallstreetdaily.com) entitled Stock Market Breadth Signals Correction Ahead.
Gula goes on to say in further edited excerpts:
Trap Door Indicator #1 – 200-day Moving Averages
One way to gauge market strength is to measure the percentage of stocks trading above their 200-day moving averages. [As can be seen in the chart below], in early July more than 90% of S&P 500 constituents were trading above their 200-day moving averages. Since then, that figure has dropped to 75%… yet the Index has continued to advance and this narrowing participation in the stock market rally is definitely not a good sign…
The market capitalization weighted S&P 500 is heavily influenced by the largest constituents, such as Apple, Microsoft, Berkshire Hathaway, Johnson & Johnson, and Wells Fargo, which have been performing admirably. In other words, the mega caps (greater than $100 billion in market cap) are propping up the indices and masking broader market weakness. Meanwhile, institutions are rotating into safer stocks as market leadership is becoming increasingly confined to larger, more stable companies. This breadth deterioration is reminiscent of similar action in late-2007 and mid-2011, both before significant selloffs.
Trap Door Indicator #2 – % of Stocks At 4-week Lows
Another way to assess weakness is to examine how many Index members are trading very poorly. As you can see below,
- Over 10% of the Index is making new four-week lows and seems to be expanding.
- New four-week lows reached 26% during one period in the past month which was higher than peaks reached in early July.
- 25% of S&P 500 stocks are down 10% or more from their 52-week highs and
- 30 stocks are actually down 20% or more from their 52-week highs, meaning they’re already in their own bear markets!
Lousy breadth is not indicative of a healthy stock market (although this situation can persist for an extended period of time like the period leading up to the apex of the technology bubble).
Bottom line: Market internals are currently not confirming the all-time highs for the S&P 500 Index. This type of narrowing leadership has been a feature of significant market tops in the past, and shouldn’t be ignored…
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
*http://www.wallstreetdaily.com/2014/09/23/stock-market-breadth/ (© 2014 Wall Street Daily, LLC. All rights reserved.)
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