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What Breadth Says About Stock Direction

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The strong rally since March is bound to be follwed by a correction, but is now the moment?

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What does breadth say about where stocks are heading?

"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'm based in Cape Town when not traveling) 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'm 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).





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're about to find out whether this is the moment. In the meantime, be cautious out there.
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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