The seven+ year bull market in US equities, which was mostly propelled by the high, Fed induced, equity risk premium, massive financial engineering, and innovation in fracking, is beginning to show signs of cracking.
No, one, metric can ever be the ultimate tell tale sign of any market event, let alone major market turning points that usually occur at the end of major bull markets, but if we were to be forced to pick one indicator that almost never fails it would be the breadth of the market. There are a few different ways in which we have seen other smart investors use it but we have created our own way of reading the market breadth. It seems reasonable, to us, to assume that the daily change in the number of new highs, and new lows is filled with noise. We prefer focusing on the long term behavior of this metric. We focus on year over year changes in Exponential Moving Averages (“EMA”) of the number of new highs, and number of new lows. On the chart above, you see raw data on the daily new highs, and new lows. In the chart below, we show you the EMAs of the new highs, and new lows.
If one, simply, used the cross-overs on the chart above as an indicator to acquire a net long or a net short exposure to the US equity market, one would have gotten short the US equity market in late 2007, long in late 2009, and short in late 2015. We know from history that the first two cross-overs gave perfect signals, what efficacy the third signal demonstrates is an open ended question, and one we will be monitoring very closely.
Below, we superimpose the above chart with Y.o.Y rate of change of S&P 500 Total Return Index and S&P 500 Price Return Index:
The S&P 500 Total Return Index, which includes dividends, is up 3% Y.o.Y and the S&P 500 Price Return Index is up a paltry 91 bp Y.o.Y. The last time these returns were at these levels was back in March 2010, and before that in May 2008.
We think the writing’s on the wall; that a major turning point to this great bull market is close. While the high equity risk premium still favors equities, over bonds, the market breadth is weakening, and that’s usually not a good time to be long beta.