Bad “Breadth” You Say? Problem Solved and Bears Gored by the Bull…Again

Join Oak Harvest for the July 23rd edition of Stock Talk! We revisit the topic of “Market Breadth,” and explain how media and Wall Street hand-wringing about the topic is over-blown in our view.

Chris Perras: Hey, Happy Friday. I’m Chris Perras, chief investment officer at Oak Harvest Financial Group. We’re an investment management and financial advisor here in Houston, Texas. Welcome to our July 23rd, Stock Talk Podcast: Keeping You Connected to Your Money. I once again started hearing those familiar calls for, “This is the top, a crash is coming.” Well, they started about two months ago, and those calls picked up speed in the last two weeks as the market’s breadth had become increasingly crowded into fewer and fewer large cap technology stocks, which accounted for most, if not all on the markets gain in the second quarter.

This week’s podcast title, The Market has Bad Breadth, You Say, What Problem or Excuse Looks to Be Solved? Before I get to this subject, I want to remind listeners that prior performance is no guarantee of the future. Well, that being said, the data we are seeing much as it was in April of 2020, in late October pre-election, and then again at early November of last year, continues to confirm, not conflict, with our continued very positive second half outlook.

Recent research notes throughout Wall Street have been littered with warnings ranging from cautious to outright bearish the last month or two because the breadth of the market has been trending lower since early June by their accounts. I want to first remind listeners, what is meant by market breadth of the market? What technicians and strategists mean when they talk about breadth is they’re trying to quantify how many or what percentage of stocks in a given index are participating in a market’s up or down move. In its simplest form, it’s just a ratio of the number of stocks advancing or those green on your screen, to the number of stocks declining, or red on your screen.

Take the S&P 500 for example, if half of the stocks closed green one day, and the other half were down on that day, the advance-decline ratio would be calculated is 253-ish, divided by 252, or about one. Yes, for those of you thinking what in the world I’m I talking about, how can there be 505 stocks in the S&P 500? Well, listeners, it’s because there are 500 companies in the S&P 500 and 5 of those companies have dual class share stocks, so those stocks are included, too.

However, since an index like the S&P 500 is market cap weighted, with Apple being the largest stock in the index at over 6% of the entire index, theoretically, Apple stock could be up, say 10% on the day, and the other 504 stocks down mildly, and the S&P 500 still show a gain on the day. It would be a gain for the index, but the overall makeup of the move that day would be very bearish or negative. The market would be said to have had very bad breadth.

Think of it as sharing a pie with your work friends, and you getting the only good fully cooked piece, that yummy piece, while everyone else around you gets the undercooked doughy remains. That would probably make for a bad conversation attitude and work environment the next day.

In the stock market, sentiment is best and is most bullish when the average stock is participating in the up move, when more stocks, sectors and industries are working, when more investors get a good slice of pie. Why? More segments of the economy are working, more and a wider variety of investors are making money, more people at the party are happy the next day versus just a few big star performers.

Well, for weeks now the fearmongering on the sell-side has been growing about how poorly the market breadth has been. Why have we chosen to downplay the narrowing breadth the last month at Oak Harvest? Here’s why. We studied history, particularly the behavior of markets since the Great Financial Crisis in 2008 and 2009 and observed that whenever long-term interest rates have peaked, be it a peak of inflation or growth peaking, the yield curve started to flatten, and market breadth peaked and started to narrow.

Looking back at the first half of 2021, market breadth actually peaked way back in mid-March amidst the out-of-bounds calls back then for 1970s inflation spirals. The calls for a breakdown in breadth of the market are actually coming at what should be the end of the trend, right at its normal time during a summer slowdown that sets up for a reacceleration in second half growth. As soon as long-term interest rates start trending higher, positive breadth indicators should explode up much as we saw this past Tuesday. Next, and this is something few strategists have published and focused on, probably because it doesn’t play to the market fears. As recently as Friday, July 9th, and then again, this past Tuesday, the 20th, the NYSE experienced a rare 90% up day, which according to Merrill Lynch, is extremely rare and extremely bullish. How rare and bullish? According to Merrill Lynch, this is just the 77th and 78th time this has happened since 2005.

The average gain over the next three months was almost 6%, and we were positive over 80% of the time. More interesting, the only other time a 90% up day coincided with a new, all-time high like we are right now, was on July 8th, 2016, just after the European Brexit vote. What happened to the stock market over the next six to nine months? Well, the S&P 500 gained almost 16% over the next nine months, post that breadth move. That’s bullish history, albeit, with no guarantees of course.

Next, while we are waiting on the exact daily data, I want to revisit a breadth reading we highlighted and discussed in early November of last year. That is The Zweig Breadth Thrust Indicator, which tracks the ratio of 10-day advances, divided by the summation of the 10-day advances and declines. When that indicator turns from below 40% to above 61.5% within 10 days, the indicator is deemed a buy.

Since 1950, this indicator has given a buy reading or signal only 24 times. Yes, only 24 times and over 70 years, and 2 of those times have come the last 15 months. First, in June of last year, and then again, in November of last year. The average gain including those two readings from 2020 produced an average return over the next six months, of almost 14%, with only an average maximum draw down of 2%.

Last year’s first quarter 2020 reading netted almost 18% over six months. The November reading, post-election, netted over 16.5% through tax day. We’re not trying to jump the gun and we are waiting on the daily data to see if a third Zweig thrust was achieved this cycle, but the 10-1 breadth up day on Friday, the 9th and the subsequent 10-1 up day this past Tuesday, on the 20th, lends a very positive backdrop for bearish calls by many strategists.

Finally, and I want to thank Josh Brown, for this material, because he published it in a note last November on market breadth. Here it is. I asked the question, “Does this topic even matter right now?” The short answer is a resounding no. Market breadth is not a coincident indicator. In fact, it has peaked a full two years ahead of the price of the S&P 500 since 2013.

The facts are, the S&P rallied another 45% between the 2013 breadth surge and the 2015 price peak. The S&P rallied another 35% between the 2016 breadth surge and its 2018 price peak. Historically, breadth thrust does not occur at market tops, nor does declining breadth portend and emanate “market crash”. This cycle, it has taken almost two years for the market to be affected by deteriorating breadth. This would put any concerns from our Oak Harvest team in the late first quarter of next year, maybe even the third quarter of next year. As far as we’re concerned, bears and strategists call for minus 10% or more, 20% crashes, recessions, you name it, they continue to be grasping at straws.

A case in point is Domino’s, reporting positive revenue and earnings yesterday, and the stock vaulting over 13% to a new all-time high. It’s summer and as far as the team at Oak Harvest is concerned, it’s a very normal one at that. It’s still a bull market, and rotations happen throughout bull markets. I’m Chris Perras, and at Oak Harvest, we’re a comprehensive wealth management financial advisor located right here in Houston, Texas. Give us a call to speak to one of our advisors. Our phone number, 281-822-1350. We’re here to help you on your financial journey into and through your retirement years with a customized retirement planning. God bless and have a great weekend.

Male Speaker: All content contained within Oak Harvest Podcast expresses the views of the speaker, and is for informational purposes only. It is based on information believed to be reliable when created, but any cited data, indicators, statistics, or other sources are not guaranteed. The views and opinions expressed herein may change without notice.

Strategies and ideas discussed may not be right for you, and nothing in this podcast should be considered as personalized investment, tax or legal advice, or an offer or solicitation to buy or sell securities. Indexes such as the S&P 500 are not available for direct investment, and your investment results may differ when compared to an index. Specific portfolio actions or strategies discussed will not apply to all client portfolios. Investing involves the risk of loss, and past performance is not indicative of future results.