Market Insights: Breadth is King

We have discussed overall market breadth in these missives many times in the past, but we would like to revisit this again today and its relevance in either leading markets or providing confirmation to the strength or weakness of a move higher or lower. The following chart is one we came across in early April. It shows the S&P 500's cumulative advance/decline (A/D) line readings for every quarter over the last 30 years. You can read a more thorough description on the cumulative A/D line in our recent blog posted titled Retest? What is very interesting is that the stock market rally we had in the first quarter exhibited the strongest cumulative breadth in a quarter over the entire period. With a cumulative breadth level of 4795, it hasn't even been close in terms of how strong this past quarter was compared to past quarters. Other than the first quarter of 2013, there hadn't been a reading greater than 3500. 

Source: Bespoke Investment Group, www.bespokepremium.com

 

What is also interesting to point out is that most of the highest quarterly readings (2003, 2004, 2009, 2012, 2013) were prior to substantial and lengthy moves higher in the equity markets. Therefore, this strong breadth we witnessed should bode well for the markets. However, the data does show that the following one quarter after these strongest moves were not particularly strong. This is not surprising as markets don't move up in a straight line, and so far, that is proving out this quarter after a difficult May. In our discussions with clients in April, we pointed out that we had an expectation for a period of consolidation in markets, and this has played out so far.

From a broader perspective, in our Q4 2018 Market Commentary, we were very clear that we felt that the substantial fourth quarter correction last year was likely event-driven (Fed policy mistake around a time of slowing global growth and trade issues) as opposed to a leading sign of recession, as many of the indicators we look at did not flash red, especially in credit markets, where we didn't see any major signs of stress. 

After enduring a 7% stock market correction in May, how has breadth held up during the decline? We have been watching this closely in May to see how much of the market was participating in the downside. As it has turned out, breadth held up quite well, and now as of Friday and again this week, the cumulative advance/decline line has hit a new all-time high again (see chart below). You can see that the low in the A/D line in May only moved down to the level of early April, when the stock market was substantially higher. Whereas stock markets in May moved back to levels from mid-February. In other words, the A/D line held up strongly in comparison to the market. This new high in the A/D line post-May correction should ultimately lead the equity markets higher, but only time will tell.