Market breadth by capitalisation size: Another look

04 July

I think that I should revise, or at least change the emphasis of what I said on market breadth last week, specifically in terms of putting more weight on the NASDAQ High/low indicator than the NYSE cumulative breadth indicators.

My reasoning was that bond funds distort the NYSE indicators and those have been strong recently, which may have caused the new highs for those cumulative indicators.

That is true but I don’t think I gave enough attention to the status of the breadth indicators for the different capitalisation size groups, which I first had a proper look at last week. These are not distorted by bond funds.

In the article of 25 June, I stated that using the High/low cumulative breadth indicator, the large cap breadth indicators (S&P 100, NASDAQ 100, S&P 500, Russell 1000, even the mid cap S&P 400) confirm the market index advance. The same was true for the advance/ decline cumulative indicator.

So that is the top 1000 stocks by market cap not showing a divergence, quite a long way down the list of stocks. The situation with the small cap section isn’t a divergence, as the small cap index does not make a new high. The small caps not keeping pace with the indices is an issue worth noting, but not as decisive as I originally suggested.

Think back to the last leg of the last bull market between mid August 2007 and late October 2007. Then, only 3 of the 10 S&P broad sectors (energy, materials, technology) participated in that index rally. Financials went sideways at best, the other six made tiny gains.

Then, think back to February/ March 2009. The financials made new lows along with some consumer stocks but energy and materials and many stocks from various sectors made higher lows, above their 2008 lows. These were proper breadth divergences and we don’t have anything like that now.

I follow the cycles work of Tim Wood and he discusses how cycles tie in with breadth divergences. He points out that breadth divergences accompany the type of cycle top that he focuses on the majority of times. This does leave room for times when these tops form without breadth divergences.

Summary

The NASDAQ Highs/ lows breadth divergence is worth noting but there is not one of those truly rare times, like in October 2007 or March 2009 when breadth is clearly diverging with the market index, giving us a high probability entry point.