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The Bulls Are Back in Town

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    November 11, 2014

    A month ago I made the case that the bears were in control and that the burden of proof had now shifted to the bulls (click for article link). As I have shown before, the basis for determining when such shifts in the market occur is by looking at the relative strength and persistence of 52-week highs and lows. If the spike in 52-week highs during rallies is greater than the spike in new 52-week lows during a decline, then the bulls are in charge and vice versa.

    While I expected the market to rally off the mid-October lows, I never expected a such a sharp “V-shaped” recovery to occur so quickly. Since 52-week highs have again overtaken lows, it looks like the bulls are back in town.

    Leading up to the September peak in the markets we were seeing new highs in the market being met by smaller and smaller spikes in new 52-week highs. This indicated market breadth was deteriorating and we were on shaky ground. Then we entered the September-October correction and the spike in new 52-week lows reached nearly 17.5% at the October bottom and more than surpassed the roughly 7% spike in new highs in the S&P 1500 during the September peak. However, with the strong advance off the lows we saw the spike in new 52-week highs reach 20% on October 31st when the Bank of Japan expanded its monetary purchases. The large jump in new 52-week highs to 20% was the best figure we had seen in all of 2014 and suggests the markets have a new lease on life as the bulls are back in charge of the market.

    S and P 1500 Breadth
    Source: Bloomberg

    Supporting this is data by Renaissance Macro’s Jeff deGraaf, who was rated ten years in a row as Institutional Investor’s number one technician and inducted into their hall of fame (click for link). Jeff took a look at over 50 years of data and found that the market is unusually strong after witnessing a surge over 55% in new 20-day highs. Such strong readings in momentum tend to kick start a multi-month rally.

    Well, on October 31st the market witnessed 57% of stocks in the S&P 500 hit 20-day new highs, a development Jeff said was the smoking gun for the bulls. What I also believe was a smoking gun for the bulls was a strong recovery in the small cap space like the Russell 2000. Small cap stocks were underperforming the market all year and saw widespread deterioration. However, the surge since October has pushed 1-month, 3-month, and 12-month new highs in the Russell 2000 to the highest level in nearly two years to levels not seen since the kick start to the strong 2013 market rally.

    Russell 2000 Breadth
    Source: Bloomberg

    There is other breadth data to suggest the bulls retain control. My NYSE Breadth Index (bottom panel below) never dipped into negative territory which usually marks the top in the market as it did in 2000 and 2007 (see red circles). At a reading of 138.845, the index is well above zero and it will take more of a topping process to push it into negative territory.

    NYSE Breadth
    Source: Bloomberg

    What should also be encouraging for the bulls is when the technical and economic data are in alignment and singing the same song, which is the case now when looking at leading economic indicators from the Philadelphia Fed. In the top panel below I show the S&P 500 in black along with the percent of stocks above their 200-day moving average shown in red and smoothed. In the bottom panel below I show the Philly Fed’s State Leading Index in black and the Philly Fed’s State Coincident Diffusion Index in red.

    Philly Fed Breadth
    Source: Bloomberg

    What is characteristic near major bull market tops is that both technical and economic breadth begins to deteriorate, which is exactly what we saw at the 2000 and 2007 tops. Heading into the 2001 recession we saw the percent of stocks above their 200-day moving average dip several times below 50% and the Philly Fed Leading and State Diffusion Indexes were both rolling over aggressively. We saw the same setup in 2007 when the percent of stocks within the S&P 500 dipped below 50%, the Philly Fed State LEI fell below 0%, and the Philly Fed Coincident Index also dipped into negative territory. When you look at where things stand today the percent of stocks above their 200-day moving average is comfortably above 50% and both the Philly Fed State LEI and Coincident Diffusion Index are resting near multi-decade highs. This is not the stuff of a bull market top or near-term recession.

    Another encouraging economic breadth statistic is the percentage of industries in the country showing expanding payroll growth. Leading up to the 2001 and 2007 recessions we saw the 3-month (red line) and 6-month (black line) employment diffusion indexes roll over strongly and fall below 50% just before or after the recessions began. Currently, the 6-month employment diffusion index rests near a fourteen year high and the 3-month diffusion index at a reading of 65.3% is comfortably above the 50% warning level with neither showing any warning signs of a coming recession.

    Employment Breadth
    Source: Bloomberg

    Summary

    Deteriorating breadth all year was something I had highlighted to suggest caution to the bulls (see “Respecting the Message of Bob Farrell’s Rule #7”). When breadth had deteriorated to the point that bearish readings like the spike in 52-week lows exceeded the readings of new 52-week highs that told me that bears were in control and the burden of proof lay at the bulls feet. That burden has more than been proven by the surge in new highs in the market and was the “smoking gun” that Jeff deGraaf said the bulls needed. Further support for the bulls also comes from economic breadth which remains firmly in bullish territory as the bulls have regained control of the markets.

    What has me most concerned when looking further out is a replay of the European sovereign debt drama, something I commented on in my last article (click for link) and a topic I plan on further expanding on in the future. Despite a bullish backdrop for US stocks and economy, Europe could still prove to be our Achilles Hill as it was in 2010 and 2011, and should be closely monitored in the weeks and months ahead.

    Images: via Flickr (licence attribution)

    About The Author – Chris Puplava, Financial Sense Online

    Chris graduated magna cum laude with a B.S. in Biochemistry from California Polytechnic State University, San Luis Obispo. He joined PFS Group in 2005 and is currently pursuing the designation of Chartered Financial Analyst. His professional designations include FINRA Series 7 and Series 66 Uniform Combined State Law Exam. He manages PFS Group’s Precious Metals Managed Account, Energy Managed Account, and Aggressive Growth Managed Account. Chris also contributes articles and Market Observations to Financial Sense and co-authors In the Know—a weekly communication for Jim Puplava’s clients only—with other members of the trading staff. Chris enjoys the outdoors.
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