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What Breadth Divergence? This Market Is Not Aging That Fast!


Divergences in market breadth are evident for the major US indices.

The poor performance of the energy sector explain these breadth divergences.

The market is not aging so fast - breadth still supports price.

The relative longevity of this present bull market seems to be a preoccupation in the media of late. The bull phase has been in place for 6 years (actually 73 months, assuming it kicked off 04/2009), significantly longer than the median bull market length since 1871 of 50 months. Being well past the median age, it has been a rampant speculation that we can expect the bull market demise just about any time now, and there are many keen eyes watching for any sign. Except it is has been awfully difficult to spot, having eluded all attempts at observation thusfar. So, the hunt is now on for signs of aging; the assumption being that, much like people who exhibit obvious signs of aging, an increasingly elderly bull market will exhibit tell - tale signs. One such signature involves market breadth, meaning the number of stocks that are participating in the bull rally. The logic goes that as the bull market ages, the relative number of stocks that are advancing diminishes particularly as the market reaches its peak. At a market peak it is usually large cap stocks that carrying the market as these are the companies that maintain investor confidence longest. In fact, diminishing breadth has been exactly the characteristic US markets have been exhibiting for the past year. The figure below shows the NYSE composite index ($NYA) compared with the number of stocks trading on the NYSE above their 200 day moving average ($NYA200R).

It is clear on this chart that the number of stocks trading above their 200MA has been decreasing steadily for about a year. This is in contrast to the increase in the index over the same time period. This divergence between breadth and price has been interpreted as a fingerprint of an aging market, and therefore, we must be approaching, or we are at, a market top. Similar divergences are evident for the S&P500 and the Nasdaq. Well, what I'm going to do now is pour cold water on the idea that we have a market breadth divergence despite what we can clearly see in the chart. What I am going to show is that this divergence arises solely from the relatively poor performance of as single sector of the market: I am sure you have already guessed which one - the energy sector, of course!

First let's look at how market breadth for the NYSE compares to the index price for 2015 only. This is shown below.

There is no significant evidence of a breadth divergence this year. Interestingly, there is a divergence starting to form since about May, but that is relatively minor at this point, and not the one we are interested in. We are interested in what has been happening since mid-2014 to decrease market breadth, but now we are clear that this divergence only lasted until the beginning of 2015. The decrease in breadth coincides nicely with the start of the tumble in oil prices, and what happened along with that? The stock prices of energy companies tumbled also. So my thesis is that the apparent decrease in market breadth is caused by the troubles of the energy sector. It's rather difficult to analyze the performance of the energy sector stock by stock to show this, so instead I took the sector ETF XLE as a proxy for the energy sector. Shown below is the price performance of XLE compared to the number of stocks in the NYSE above the 200 MA.

The decrease in the NYSE breadth is coincident with the decrease in XLE, and moreover XLE has failed to recover above its 200MA ever since. A similar examination of the 8 other sector ETFs shows that price stayed above its 200MA for most it not all of the time range shown in these charts. I've included a couple of examples below, but all other sector ETFs exhibit similar characteristics.

The significant price decreases experienced by the energy sector had the effect of systematically lowering the number of NYSE stocks above their 200 MA. This lowered the whole breadth curve causing the divergence with price, but once XLE bottomed, the breadth correlation with the index returned.

The other measure of market breadth that is often used is the advance - decline line. This has not shown significant divergence with the price over the past 2 years, as shown below for the NYSE.

Removing the artifact introduced by the energy sector troubles from the 200MA data, both these measures give a consistent picture of breadth supporting the recent advance in the index. So, the breadth data doesn't provide any support for the contention that the market is now overly elderly, and by extension that we are not at a market top.