A Brief Bear Cycle Gives Way To A Bullish Shift In Market Breadth

Summary

• The percentage of stocks trading above their respective 50-day moving averages ended its downtrend.
• The apparent expansion in market breadth signals a broadly bullish shift in trading that should benefit more and more stocks.
• Trading in small caps and the economic signals critically important to small companies look to provide the key pivot point for market breadth.
• Even the percentage of stocks trading above their respective 200-day moving averages looks like it has finally bottomed.

monsitj/iStock via Getty Images

In late September, I stepped in front of another predictable bounce in the S&P 500 (SPY) to wave a warning about a bearish change in the character of trading on the index. The S&P 500 proceeded to drop and even made a new lower low. The bear cycle began its demise there and delivered just one more fade opportunity. Overall, the month of October hit a historic extreme with a minimal maximum drawdown that eventually created the current bullish shift. Market breadth has finally swung from a weight on the market's underlying health to a firming support. As measured by the percentage of stocks trading above their respective 50-day moving averages (DMAs), or what I like to call AT50 for Above The 50, market breadth is in an expansion mode.

Source: TradingView.com

The chart above shows that for most of this year, market breadth was on a decline. While the ultimate low happened in July, both the primary and secondary downtrends (shown by the thick, diagonal black lines), capped rebounds in market breadth. However, the breakout in market breadth on October 17th accompanied a breakout for the S&P 500 above its 50DMA resistance. That combination brought the bear cycle to an official end.

This combination provides important perspective for another a breakout in small caps that underlines the current expansion in market breadth. In the past two weeks or so, big shifts in AT50 occurred in parallel with shifts in the iShares Russell 2000 ETF (IWM). IWM soared 2.6% alongside the 9-point move that took AT50 to a 7-month high. In other words, the brief bear cycle from September now gives way to a bullish shift in market breadth.

Source: TradingView.com

The chart above of IWM shows how small caps as a group remained trapped in a well-defined trading range for most of this year. While the S&P 500 printed a predictable uptrend defined by its 50DMA, IWM travelled a predictable path to nowhere. That path may give way to a long overdue breakout if two economically sensitive events work out well for the market.

The Wildcards

The Federal Reserve meets this week to deliver its latest pronouncements on monetary policy. The Fed should provide incrementally more clear guidance on its moves to tighten monetary policy. The Fed is now behind central banks like the Bank of Canada in painting the path toward monetary tightening. If the Fed successfully replicates the Bank of Canada's message of tighter policy, a strong economy, and controlled inflation, then the positive economic prospects should help boost confidence in small cap companies.

On Friday, the U.S. delivers another jobs report. Generally, recent jobs reports have delivered little to no sustained changes in market sentiment or trading. However, if the jobs report for October reinforces a Fed message of controlled inflation embedded within a strengthening economy, then the market should get a confirming catalyst for expanding market breadth.

The Trade

These wildcards sound like weighty "ifs", but they seem reasonable in the context of the bullish expectations embedded in expanding market breadth. There are many examples from individual stocks. I offer one in particular from a stock I panned in March of this year: Live Nation (LYV).

LYV stopped cold at the bottom of its previous uptrend channel and proceeded to sell off. However, the subsequent pullback in LYV was relatively mild. Earnings in May provided investors sufficiently reassuring signs to carve out a bottom in the price action. It took a retest of that bottom and another 5 months before LYV delivered a breakout to a new 2021 high. Along the way I moved into a long position (call spread) thanks to a trading idea from Dan Nathan of CNBC's Fast Money fame (through Fidelity's "In the Money"). Today, LYV tacked on another 2.8% to notch a fresh all-time high. This breakout aligns well with the expansion in market breadth.

Source: TradingView.com

I particularly like stocks like Spotify Technology (SPOT) which have just recently confirmed breakouts above their 200DMAs. I wrote about SPOT in an earlier piece given the stock looked well-supported by an aggressive buyback. SPOT is on a 4-day winning streak that includes a 200DMA breakout for a post-earnings reaction.

Source: TradingView.com

The 200DMA breakouts are particularly interesting because the percentage of stocks trading above their respective 200DMAs, what I like to call AT200, looks like it finally bottomed last month. Today, AT200 closed at a 2-month high. A bullish turn for market breadth has a LOT of upsides ahead based on AT200.

Source: TradingView.com

Expanding market breadth combined with all-time highs and important breakouts make for a bullish brew. This mix has all happened just in time for the start of the stock market's seasonally stronger period (November to April). While valuations seem sky high and buying due for another rest, I have to keep reminding myself that this market flush with liquidity puts a premium on price trends, momentum, and a good narrative.

Be careful out there!

Analyst’s Disclosure: I/we have a beneficial long position in the shares of LYV either through stock ownership, options, or other derivatives. 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.