As pertains to the stock market, I am beginning to see more grandmother stories crop up in an attempt to explain what has turned into a defy the skeptics rally over the past two months. I am seeing all sorts of reasons why equities are higher and why they should continue higher. To this I respond: "what nonsense, Bubba Meises!"
Geez, if I had known all this 2 months ago, I wouldn't be so stupid.
One of those market myths is breadth. (See these links: here and here.) Bulls claim that the market will continue higher because breadth as measured by advancing and declining issues is so strong. While good breadth during a price advance is a positive, I will take the opposite tack and ask the bulls: do you ever trade a rally where breadth is lagging the price action? I am sure the answer is "absolutely yes". In other words, if you are going to define your bullish posture based upon the use of breadth, then you have to do this all the time. You just can't do it selectively.
To further my point, take a look at figure 1. This is the S&P500 with the NYSE cumulative advance decline in the lower panel; the graph covers the period from 1996 to 2001. At the vertical line labeled #1, the cumulative advance decline hit a multi decade high. Oh, for the next 26 weeks the S&P500 went side ways, and for the 21 weeks after that the S&P500 went some 20% higher. What was the cumulative advance decline line doing during the rally? Oh, it wasn't heading higher with price.
Figure 1. NYSE Cumulative Advance Decline/ weekly
And what happened after that? The S&P500 fell some 25%. What did the cumulative advance decline do? Actually, the cumulative advance decline line hit its lowest point in about 52 weeks (see vertical line labeled #2). By the rational of the bulls, if they were consistent in their approach, the market should have kept going lower. After all if strong breadth and breadth thrusts and all those things we use to explain the unexplainable are a sign of a strong market then, weak breadth must be a sign of a weak market.
Lastly, look at vertical line labeled #3. Here the cumulative advance decline line hit another multi- decade high in January, 2000. Shortly there after, the S&P500 made a bull market high and the market embarked upon a 24 month bear market.
I rest my case. This is "Bubba Meises!"
If you use an indicator to explain the price action or your position in the market, then don't use it selectively. If you use a breadth indicator such as the advance decline line, then you should also look at volume indicators and new high and new low data as well. With regards to the current rally, these metrics are lagging and not as robust as the advance decline data. So please explain that to me.
I do follow market breadth - all of it, everyday. But in my practice, market breadth adds little to the information that I get from the price action. I see no reason to make trading decisions based upon market breadth.
Lastly, one of the aspects about this cyclical bull market rally has been the ability of the bulls to extrapolate into the future the meaning of higher prices. The stock market is up, so it must mean something good. In my opinion, market participants are looking for reasons as to why the market is higher, and they selectively apply what they want to validate that position. But I doubt there is anyone out there who would have thought a year ago that the S&P500 would have almost doubled from its March, 2009 low. I doubt there was anyone indicator that would have suggested to hold on tight for the next 15 months and you will be rewarded.