Perma-bulls on the major networks routinely gloss over the reduction in stock market breadth. For example, 60% of the Dow 30 components currently sit below long-term moving averages. When companies like Coca-Cola, Wal-Mart, DuPont, Intel and Verizon are simultaneously suffering from rally fatigue, one might anticipate an eventual breakdown in the gravity-defying direction of popular benchmarks like the Dow and the S&P 500.
It is not just companies in the Dow that are struggling. Most of the individual sector investments have dropped below key trendlines, including telecom, staples, utilities, real estate, energy, industrials, basic materials and transports. What is keeping the dream alive? Health care on the back of biotech (dot-com 2.0), financials on the expectation of higher interest rates and consumer discretionary on the debt-fueled desire to borrow-n-spend.
Why should a stock investor even care about something like market breadth – something that sounds stinky and is not as easy to see as the current price of a big-time benchmark? It is because the indexes that the media cover do not treat all stocks in the same manner. For instance, the Dow is weighted by price. In fact, just the other day, a spike in the price of Nike shares powered the Dow to a positive finish, even though an overwhelming majority of corporate shares finished in the red. Apple and Nike have a disproportionate influence on the direction of the Dow because they have some of the highest nominal prices. Similarly, the S&P 500 is a market-cap weighted benchmark that allots more weight to stocks with the largest market capitalization.
In contrast, each stock in a market breadth indicator is given equal footing. This makes it possible to determine how the overall stock market is participating and whether or not the majority (or minority) of shares are participating in a particular uptrend or downtrend.
With the first half of 2015 coming to a close, how might we characterize the breadth of the U.S. stock market? Musty and mildewed. I have already pointed out the lack of breadth within the Dow and across the sectors. Perhaps more importantly, investors need to pay attention to the Advance/Decline (A/D) Line of the New York Stock Exchange. One can see the breakdown in the number of advancers participating in the bull market relative to wavering decliners in the chart below. (Note: “Sell in May and go away” might have been good advice here in 2015, since this indicator has not been this close to crossing under its 200-day since the beginning of 2012.)
Breadth weakness can be identified in additional ways. We can also take note of declines in the Bullish Percent Index (BPI). This breadth indicator fluctuates between 0% and 100%, though it is rarely seen at the extremes. The BPI for the S&P 500 may still be indicative of bullishness with a reading above 50% (59.4%), yet less and less S&P 500 components have been forging uptrends. Throughout most of 2013 and 2014, new S&P 500 stock market highs hit when the S&P 500’s BPI hit 85%. Over the last eight months, 75% became the new participation level when the benchmark had hit new records. Today? 59.4% represents troublesome deterioration in market breadth.