What Does Breadth Say About Where Stocks Are Heading?

By: Prieur du Plessis | Tue, Jan 26, 2010
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"Where breadth goes, the market usually follows," goes an old market saying. Breadth indicators are useful tools to assess the inner workings of the market's rallies or corrections, and are used to identify strength or weakness behind market moves, i.e. to assess how the bulls and the bears are exerting themselves.

First, a quick review of the stock market scoreboard. The MSCI World Index and the MSCI Emerging Markets Index have declined by 4,8% and 6,7% respectively since the highs of January 11. Following its sharpest three-day decline since March last week, the S&P 500 Index is down by 4.7% since the peak of January 19, the Dow Jones Industrial Index 4.9%, the Nasdaq Composite Index 4.7% and the Russell 2000 Index 4.8%. After yesterday's bounce from short-term oversold levels, US stock market futures and foreign bourses are heading down again.

The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based in Cape Town when not travelling) are given in the table below. With the exception of the Russell 2000 Index and the Russian Trading System Index, the indices in the table are all trading below their 50-day moving averages. The S&P 500 Index is threatening to break below its December low of 1,092 and also to breach an upward sloping trend line that extends from the August lows. A decline below these support levels could signal a deeper pullback.

Although at this juncture all the indices are still trading above the key 200-day moving averages - an indicator of the primary trend - one should keep a close eye on these important levels. (The Shanghai Composite is a mere 64 points away from its 200 DMA as I am writing this post.)

Back to market internals: The number of NYSE stocks trading above their respective 50-day moving averages has declined to 49.7% from 86.2% at the beginning of January (see top chart below). In order to be bullish about the secondary or intermediate trend, one would expect the majority of stocks to trade above the 50-day line. Based on this indicator, and also the 50-day moving average of the S&P 500 Index itself, the intermediate trend may be in the process of turning down, but a few days are needed to confirm the breaks.

For a primary uptrend to be in place, the bulk of the index constituents also need to trade above their 200-day averages. The number at the moment is 82.5% - somewhat down from its early January high of 88.7%, but nevertheless still firmly in bullish territory (see bottom chart below).

Source: StockCharts.com

Source: StockCharts.com

Also focusing on the short-term technical picture of the S&P 500 Index, Adam Hewison (INO.com) provides a brief analysis advocating that one should be out of the market at the moment. Click here to access the presentation. (The analysis was done on Friday morning, but is still as relevant today as it was a few days ago.)

It goes without saying that the strong rally since March is bound to be followed by a correction at some stage. We are about to find out whether this is the moment. In the meantime, be cautious out there.



Prieur du Plessis

Author: Prieur du Plessis

Dr Prieur du Plessis

Dr Prieur du Plessis

With 25 years' experience in investment research and portfolio management, Dr Prieur du Plessis is one of the most experienced and well-known investment professionals in South Africa. More than 1 000 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns. He also published a book, Financial Basics: Investment, in 2002.

He holds the following degrees: BSc (Quantity Surveying) (Cape Town), HonsB (B & A) (cum laude) (Stellenbosch), MBA (cum laude) (Stellenbosch); and DBA (Doctor of Financial Management) (Stellenbosch).

Prieur is chairman of the Plexus group of companies, which he founded in 1995. Previously he was general manager: portfolio management at Sanlam, responsible for the management of investment portfolios with total assets in excess of $5 billion.

Plexus is a pioneer in the mutual fund industry and has achieved a number of firsts under Prieur's leadership. These include the authoritative Plexus Survey, a quarterly analysis of the consistency of the performance of unit trust management companies, the Plexus Offshore Survey, the Plexus Unit Trust Indices, and the PlexCrown Fund Ratings.

Plexus is the South African partner of John Mauldin, American author of the most widely distributed investment newsletter in the world, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.

In 2001 Prieur received the Santam/AHI Business Leader of the Year award for corporate leadership, business acumen and entrepreneurial flair. He was also profiled in the book South Africa's Leading Managers (2006). Plexus received the AHI/Old Mutual Enterprise of the Year award in 1997 and was also included in the book South Africa's Most Promising Companies (2005).

Prieur is 52 years old and lives with his wife, TV producer and presenter Isabel Verwey, and two children in Welgemoed, Cape Town. His recreational activities include long-distance running, motor cycling and reading. He belongs to the Cape Town Club, Johannesburg Country Club, Gordon's Bay Yacht Club and Swiss Social & Sports Club.

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