The technical picture of the US stock market isn’t all that healthy right now. In fact, the only other time we have seen divergences in breadth this large was during the blow-off years of the tech bubble. Bottom line: Breadth levels are warning of a possible market top.
Let’s first start by looking at the S&P 1500, which offers a much larger sample size vs. the S&P 500, to gauge the true state of market breadth and how it compares historically. For the breadth measure, we show the spread between the percent of stocks within 2% of their highs and the percent in bear markets.
Doing so, we see that the only other time in the past 20+ years the divergence between those two was this large (lower than a net -15%) was late 1998-2000.
The 2000 Top
The 2000 tech bubble top was associated with major breadth deterioration from 1998 until the final peak. Notice the spread never got back up to a much healthier range.
The 2007 Top
The final high in October 2007 saw the spread at -9% before hitting new lows for the cycle.
From 2009 to the January 2018 top, we have consistently seen the spread in positive territory as the S&P 1500 hit new 52-week highs.
At no point during the advance from the 2018 spring lows to the Sep-Oct highs did the spread reach positive territory, a first during the entire 2009-present bull market. Moreover, since the late 2018 peak in the S&P 1500, the spread has not breached the -15% level even while the market hit a new 52-week high, the first occurrence seen in two decades as this hasn’t occurred since the late 1998-2000 tech bubble blow off run.
The divergence during the tech bubble was caused by the most extreme weighting to tech stocks ever seen in the S&P’s history. This time around technology stocks continue to have an outside influence on the market’s performance relative to the average sector, but I believe it is not just sector weighting but in fact more of a market capitalization issue driven by record buybacks in the U.S.’s largest companies.
When we examine the data for the S&P 500, as long as the spread between those within 2% of their 52-week highs and those in bear markets was positive (as the S&P 500 hit new highs), the market was in good shape typically overall. The first significant correction in the S&P 500 after it hit a 52-week high with the spread in negative territory came in 1998 during the LTCM crisis.
From that point on through the end of the bull market in 2000, the spread never breaching into positive territory again as the last two years was a technology-driven market.
Interestingly, despite the S&P 500 entering a devastating bear market over the next three years, at several points late in 2000 and in the middle of 2001 the spread between those near their 52-week highs and those in bear markets nearly turned positive as many sectors had already made significant recoveries while the tech-heavy S&P 500 continued to slide. In fact, several times in early 2002 saw the spread turn positive as the market was showing early signs of a bottom as new sectors like energy and materials were taking market leadership away from technology.
Going back to the mid 1980s, the only major market top in the S&P 500 that occurred with the spread above a net +10% was the 2007 top.
While there was no early warning near the 2007 top, moves by the spread below a net -40% have shown to be consistent negative breadth thrusts that signal a bear market has started and remain in force until the spread turns positive. We saw these bear market thrust signals generated on August 1998 and January 2008.
We also saw false signals during this bull market in 2010, 2011, 2015, 2016, and 2018 that were arrested with central bank easing and negated with a move back into positive territory. However, over the last 18 months we have seen a consistent erosion in market breadth when looking beyond just the S&P 500, similar to what we saw in the final two years of the technology bubble. I believe the primary cause for this is the record buybacks we are seeing which is primarily occurring in the largest companies within the market, with the technology sector leading all other sectors in total buybacks over the last two years.
To illustrate this erosion, let’s look at the various indices and their member’s average/median decline from their 52-week highs at the two 2018 peaks as well as levels as of 07/12/19 when the market was hitting a new high. I am seeing continued deterioration in the average stock even while the market indices make new highs.
Divergence Between Indices & Their Members Continues To Worsen
You can see this visually when the historical spread of the S&P 500’s deviation from its 52-week high and its average member’s deviation is graphed. The spread widened from the spring 2018 low to the Sep-Oct 2018 peak, suggesting the rally was on shaky ground. The spread improved late in 2018 as the S&P 500 fell more than its average member and then in January of this year the spread improved further as the average member rallied more than the S&P 500. However, since February the spread has deteriorated to the worst levels seen since 2016 and makes the current rally highly suspect and not broad-based.