The chorus of cries of “weak breadth” and ” weak internals” has intensified in the past couple of weeks. The S&P 500 index has remained near all-time highs, but the Russell 2000 has severely lagged. Many measures of breadth have been weakening for months, though the persistent uptrend of the past couple of years has shaken off such divergences on all occasions.
Nonetheless, I wanted to bring attention to one measure of breadth that hit its lowest level since November 2012 yesterday – the percentage of NYSE stocks closing above their 200 day moving average:
The measure closed at 49.72% yesterday, below 50% for the first time since Nov. 2012, indicating that more than half of NYSE stocks closed below their 200 day moving averages yesterday. What’s surprising about the weakness in that measure is that the S&P 500 index is still nearly 5% above its 200 day moving average, and the equal-weighted S&P 500 index is around 4% above its 200 day moving average. In other words, the majority of the weakness in NYSE stocks is coming from stocks outside of the S&P 500 index, so it’s one more indication of the distaste for small cap stocks.
However, it’s still rare to see the S&P 500 index so well above its 200 day ma when this measure is around 50%. I went back and looked at the times in the past decade when the SPX sold off to touch its 200 day moving average after being above it for at least one month. Each of those instances is marked in green:
In the 2005 and 2006 instances, the percentage was near or actually above 50% on each touch, indicating better than average internals. In the August 2007 touch, it had deteriorated to around 45% when the index first touched the 200 day ma. However, when the S&P 500 index sold off again to its 200 day ma on November 7, 2007, the measure was around 36%, much weaker than anything throughout the prior bull market. The SPX index would not close back above its 200 day ma until June 2009.
In the most recent bull market, the first touch of the 200 day ma from a sustained rally was on the flash crash day of May 6, 2010. More than 60% of NYSE stocks were actually above the 200 day ma by the close of that week, even as the S&P 500 index closed near the 200 day ma on May 7.
The situation was much different the next time the index touched its 200 day ma after at least one month above the moving average. That occurred on August 1, 2011, and the percentage of NYSE stocks trading above the 200 day moving average was only around 33%. The S&P 500 index promptly fell another 15% after that touch.
Finally, the June 1st, 2012 touch was probably the biggest fake-out. The S&P 500 index touched its 200 day ma on June 1st, and the above 200 day ma percentage was around 36%. However, the S&P 500 index rallied shortly thereafter. It touched its 200 day ma once again in November, but the above 200 day ma percentage was around 50%, showing better breadth, and the S&P 500 index has not touched its 200 day moving average ever since.
With this backdrop in mind, if the weak breadth continues, it would signal particular danger if the S&P 500 index sells off towards its 200 day moving average in the coming weeks. Were that to occur, the percentage of NYSE stocks above the 200 day ma would probably be below 40%, or near the low end of the readings of the past decade. When breadth is weak overall, history has shown that the odds of a larger selloff are higher. That is not to say that such a move is pre-ordained, just that the odds are higher.
Given those odds, implied volatility in the U.S. equity market still looks too low, with the VIX still only around 14. Of course, 2 years without a real selloff can condition traders to ignore the risks, since it’s been costly to adhere to any warning signs throughout that period, whatever the odds.