Breadth Buckles Again

We’ve been closely following stock market breadth for signs of a resumed bear market. Breadth had been exceptionally poor until just a few weeks ago we noted the first signs of broadening out. This led to a sharp rally culminating in a blowoff last week.

Both that broadening out and the rally were left for dead this week.

Financology follows three distinct market breadth metrics: 1) The Russell 2000 versus the Russell 1000, 2) The S&P 500 equal weight versus the S&P cap weight, 3) The the rest of the world versus the US.

Breadth is failing on all three cylinders.

What does this mean? At root it is a divergence between things that normally correlate. There are two ways any divergence can correct; either A can return to B or B can return to A. We saw a spasm of the latter over the past few weeks as the lagging soldiers played catchup with the leading generals. This week they all deserted.

The averages are once again being bouyed by just a handful of supercaps as the rest of the market deteriorates out from under them.

The tactical implications depend on your starting position and where you want to go. Investors still below their target stock allocations could use this as an opportunity to add to positions in the rank and file at relatively attractive prices. Those who are in cap weighted indices, heavy in that handful of generals, could use this as an opportunity to either reduce stock allocations or reallocate away from the few and towards the many. Although the latter are still vulnerable to broad stock market declines, they at least offer decent long term return prospects for the risk.

The short version is this: I wouldn’t want to be fully allocated to the cap weighted market at this juncture.

There is no such thing as risk free investing, but the evidence suggests there is less risk per unit of prospective return in owning the market underweighted in supercap growth.

We’ve previously cited a portfolio of ETFs designed to do this and plan to post an update soon. In addition, we’re once again overweighting cash USD.

Index traders can watch the 4200 level on the S&P. A month ago we were watching it from underneath, observing that “The S&P is knocking on a widely watched glass ceiling around 4200. If it convincingly breaks through, traders will take it as an all-clear and run with it.” It did and they did. We’re in the opposite position now. If it breaks below, it opens a trap door.

5 thoughts on “Breadth Buckles Again

  1. jk says:

    fwiw my only equities are in commodities – oil and gas, uranium, agriculture including fertilizers. and that probably adds up to only about a 20% allocation.

    though the generals are at nose bleed levels, even the privates are not cheap

    1. Bill Terrell says:

      For sure even the privates could see considerable downside. My rationale for allocating there is that they at least have enough longer term return prospects to justify taking the risk. If someone could tell me when they will hit bottom, I’d gladly wait … but alas no one’s crystal ball is that good!

      The alternatives all have problems too. I like commodities too, but not enough to make them 100% of my portfolio. I’ve been and remain bullish on Treasuries, but it’s the opposite situation there … potential cyclical upside but bleak longer term prospects. And as an income investor, what I might sell my stocks for isn’t the main consideration, dividends are. And in value and outside the US you can find some pretty attractive yields. So FWIW I hold all three asset classes … and for now a bit extra cash…

  2. jk says:

    pbr/a pays a monster dividend to compensate for the political risk. worth about a 75bps allocation for me.
    i have a somewhat smaller allocation in ec.
    more conservatively there’s epd, and smaller in et.
    i count all these as commodities.

    1. Bill Terrell says:

      That ultrafat PBR yield reflects an ultralow price if the dividend is anywhere near sustainable. CRESY recently reintroduced a dividend and rocketed higher, though it may have overshot … obvious risk given the macro picture in Argentina as well. I like MLPs in general and EPD in particular, but don’t do them any more. It takes some specialized expertise to avoid a situation where you get fat but declining dividends. AMLP’s have been sagging for years, and it even reverse split the stock. My main energy stock isn’t even an energy stock … TPL … it’s down by around half over the past few months but still up a couple hundred times over the last twenty years (if it gets cut in half again it might be a buy). Some of my favorite ETFs have fairly good energy exposure (direct in the case of COMT) so that’s as far as I go with individual names.