The S&P 500 Just Took One On The Chin, Long-Termers Need Not Sweat

by: James Brumley

Breadth and depth have already taken a bearish turn.

Long-term investors shouldn’t read too much into the short-term bearish clues.

The scenario mostly calls for modest defensive action, and possibly a hedge.

Stocks go up and stocks go down. Most of the time the daily gyrations mean nothing. Even the 2.6% tumble we’ve seen the S&P 500 take since Monday’s peaking isn’t all that noteworthy, in the context of the two-month run-up we saw take shape right before the lull. The market deserves a break.

This is a funny business though. If you catch traders in the wrong mood in the wrong scenario, you can see some rather unexpected outcomes. And, although March is usually a bullish month and the prospect of an end to the trade war is on the horizon, the S&P 500 is just one bad day away from a somewhat significant breakdown.

And, the red flags have actually been waving for a while.

Bulls Losing Interest

To alleviate any fears before they take shape, this isn’t a call for the beginning of a new bear market. It’s not even an outlook for a full-blown correction… at least not yet. It’s just an explanation of how and why the S&P 500 could peel back a bit before renewing its bigger-picture uptrend.

Breadth and depth aren’t discussed all that often, and then, only broadly. They’re a little more philosophical than most investors are willing or able to be, and doing something with the data – like interpreting it – isn’t always easy.

It’s worth the effort though.

Breadth is, in simplest terms, a comparison of the number of stocks that are advancing versus the numbers of stocks that are falling on any given day. Having more advancers is bullish. Having more decliners is bearish.

Depth, on the other hand, is a contrast of the volume behind the trading of stocks that are rising versus the volume of stocks that are falling. The volume-based data is generally more telling, as it gives a clearer picture not just of direction, but also conviction. That is to say, when investors are truly convinced an individual stock or the broad market is destined to go higher, they generally buy en masse.

But, how does one get or even interpret the daily breadth and depth data?

Most for-pay charting services have it, and though it’s not necessary to utilize the data, it certainly makes it easier.

The image below is one such chart, comparing the S&P 500 to (from top to bottom) the NYSE’s bearish volume (DVOL), the NYSE’s bullish volume (UVOL), the NYSE’s daily decliners (DECL) and the NYSE’s daily advancers (ADV). Those data points are plotted with vertical histogram bars. But, it’s the lines that are moving in a mostly horizontal direction across each data set’s plot that are of the most interest. Those are moving average lines that mark the broad trend for each data set. As one would expect, the trend marked by the NYSE’s down-volume moving average line has been on the rise for the past five trading days, while the NYSE’s up-volume trend line has been inching lower.

031019-sa-depth Source: TradeNavigator

That’s not the most interesting view of this data though; we all innately know this week hasn’t exactly been bullish. Rather, the more noteworthy application of the idea is overlaying the depth/volume-based trend lines and overlaying the breadth-based trend line (as indicated by moving average lines). This view shows us that depth flipped to a net-bearish condition this week, but only after several weeks of deteriorating bullish volume, and increasing bearish volume.

Source: TradeNavigator

Breadth isn’t quite to a bearish condition yet, though it’s getting close.

What’s most interesting – for bearish reasons – is that the trends leading to this flip to a bearish undertow actually started to take shape in late January, even while the S&P 500 and other indices continued to rise. It was a fairly hollow rally, however, and not built to last. Participation waned the longer it went on.

In that light, last week’s tease of at least a minor break has to be taken seriously, even if a major stumble isn’t what’s ultimately in the cards.

Lines in the Sand

While the stage may be set for a pullback, it’s not necessarily set for a particularly big one, if one takes shape at all.

As of Friday, the all-important 200-day moving average line - plotted in green on the daily chart below - failed to hold the S&P 500 up. It's a shot across the bow of the bullish trend. The market will get a chance to undo that damage, but it won't get a very long chance, and it won't get multiple chances. This week is going to be a make-or-break period.

Source: TradeStation

The bears have another edge that may come back into play. Aside from the bearish breadth and depth already illustrated, there’s clearly something about the technical ceiling at 2815 would-be buyers don’t like. The index won’t dance with that hurdle indefinitely, even if that means retreating far enough to build up some momentum it can use to punch through it in the future which may be what's unconsciously taking shape here.

The trick is figuring out how far the market might have to fall to put it back in a bullish gear. The 2670 area, where the 50-day and 100-day moving average lines are about to converge, is the first best bet.

And that’s an important level to bear in mind, even if only for anecdotal reasons. A slide back to that area will still only translate into a 5% pullback, which in the grand scheme of things isn’t all that remarkable. It would be a run-of-the-mill stumble.

It will certainly feel remarkable, however, if the financial media latches on to that idea. The media might even be able to incite a break under that likely support level.

Bottom Line

If your instincts are telling you none of this really matters to your portfolio, then trust your instincts, because none of this really matters for true long-termers. To that crowd, the bull market is still alive and valuations are still fair. The S&P 500’s Q4 earnings are up 3.5% despite lousy technology earnings, and the trailing P/E is a reasonable 18.2. The forward-looking P/E is 16.6. There’s not a lot of adjustment that needs to be made, valuation-wise.

Nevertheless, most of the buy-and-hold crowd have more short-term traders in them than they care to concede.

If nothing else, even a small, short-term dip is a buying opportunity for purchases that have been on hold, and a reason to take profits on holdings investors aren’t truly married to. It’s a set of clues that could justify a hedge against a pullback. Tougher longer-term decisions won’t have to be made until and unless the 2670 area fails to hold up as support.

In the meantime, we’ll be looking for breadth and depth to take a turn for the better again. That will happen before it’s clear the S&P 500 itself is back on solid ground.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.