90% Days?  No Big Deal

Posted At 9:05 AM EST

Good morning...We begin the day with some modest buying pressure in the pre-market futures as once again early-morning weakness has been bid up as we approach regular trading hours.

The big focus from here is tomorrow's payroll report, which is really the big event for the rest of the month as we will be seeing volume start to ease over the coming weeks, heading into the last two weeks of the month when we traditionally see the longest stretch of very light volume of the entire year.

When the market exploded out of the March low, we went over many studies and indicators at the time that suggest "this time was different", meaning we were likely in for a rally that was unique compared to other bear market rallies.  The buying pressure was so intense and so persistent that historically the probability was good for larger, and longer, gains than we'd seen previously.

One of the signs we looked at was the concentration of extreme breadth days.  On March 24th, we discussed the fact that never before had the NYSE seen 5 days within a two-week window when at least 90% of all volume flowed into shares that closed positively on the day.

One of the concerns in that comment was that the volatility of breadth had ramped up compared to what we've seen historically.  It was becoming more common to see extreme breadth days, and like most everything else in life, the more abundant something becomes, the less value it is usually assigned.

Let's look at this another way.  The chart below shows days when breadth on the NYSE makes an extreme, defined as 80% or more of all stocks either rising or falling relative to the previous day's close.  The top part of the chart is the VIX index of implied volatility.

As we can see from the chart, when the VIX spikes higher, we usually see a cluster of extreme breadth days.  That makes perfect sense - the VIX typically rises during times of extreme market volatility, so the two should go hand-in-hand.

But look at the last few years, and the last year in particular.  There are so many blue bars (extreme breadth days) that it has become almost one solid chunk.  And perhaps the most important part of that is that it is occurring while volatility is declining precipitously.

While the VIX is still marginally higher than its long-term average, it has declined around 70% from its levels last fall.  We've really seen no letup in extreme breadth days this year, even while the volatility of price movements in indexes like the S&P 500 has cratered.

This is not something we've seen at any other point in the past decade - most certainly not anywhere near this degree.  Even if we take this back to 1965 (using historical volatility instead of implied volatility), the results are the same - we've never really seen a period where we witnessed so many extreme breadth days while volatility was declining so rapidly.

What's it mean?  Well, it means something has changed.  For whatever reason (insert your favorite excuse here), we're seeing more days of extreme correlation among disparate stocks than we've seen in the past.  More than before, we're getting "all in" days where seemingly everything either rises or falls together.  That's pretty normal during times of chaos and distress; it's very unusual during times of relative calm like now.

The bottom line from all of it is that we probably have to discount the meaning of what "extreme" breadth really is, compared to historical readings.  The significance of 90% days and other types of breadth extremes has been watered down to a degree we've never witnessed before.

Bottom line - Intermediate-term Outlook: Neutral (since April 9, SPX 843)

Beginning in early March, we discussed a large number of reasons to expect an imminent rally of one to three months' duration.  Some of those studies were even more positive, and suggested not just a rally, but possibly a new bull market.

During mid-April, the market held up extremely well in spite of some overbought types of indications.  This is very rare during an ongoing bear market, and added to the idea that "this time is different" in terms of bear market rallies, as we reiterated in early May.

Due to a variety of factors that we discussed in June, I was looking for the first breakout above 950 to be beaten back.  After happened and we neared the lower end of the May - June range, we needed to see how the market responded to oversold conditions.

On July 10th, we looked at a number of short-term oversold readings, and like a good market does, it responded by rallying strongly.  It took a couple of days, but the rally since then has been remarkably resilient, rolling over a multitude of very consistent indicators and studies that argued for a pullback last week.

As we discuss ad nauseam, a market that does not respond to short-term extremes usually has more work to do in the direction of the extreme, and that held true this time as well.  Given how well the market has responded to overbought conditions, it does bode well for the coming weeks (see here and here as well).

About the only two things that would negate these positives is a relentless move back under 950 that gives us the opposite conditions - a market that doesn't respond to oversold conditions by rallying - or a historic level of excessive optimism as the market rallies into possible resistance (1000-1025 on the S&P).  There are an increasing number of suggestions that that optimism is to creeping into our indicators, but it is not overwhelming evidence just yet.

Bottom line - Short-term Outlook:  Neutral (since July 23, SPX 955)

As was the case the day before, we had a couple of signposts suggesting weakness over the coming one to two weeks.  Along with a number of overbought indicators we watch, the suggestion was that the S&P should have trouble if it rallied into the 1005 - 1010 zone.

It pushed into that zone on Tuesday, and failed - but like nearly every other day for the past three weeks, late buying pressure pushed us up to close near the day's high.  Same thing yesterday - early weakness led to a mid-morning low, then a choppy move higher into the close.  I've lost count of how many times we've seen that lately.

There are a couple more warning signs, for what they're worth.  The latest AAII survey of individual investors showed the most bullish responses of the entire bear market, other than a couple of weeks in early May 2008 (as the market was forming a peak).

And on the flip side of the smart money / dumb money coin, corporate insiders have moved to their most bearish position of the entire bear market, moving to a buy/sell ratio last seen in early February 2007 (right before we took the big dip to end that month).  Their ratio for stocks specific to the S&P 500 is the most extreme since May 2007, and for the Nasdaq 100 the most extreme since November 2006.

So nothing at all has changed.  There are a relatively large (and increasing) warning signs out there, but so far traders don't seem to care, or at least care enough to give us any more than a -0.5% decline (for the 21st straight day).  These kinds of momentum markets can continue for weeks on end, though they almost always end in a volatile decline that wipes out most or all of the gains in an extremely short period of time.  I believe the same will happen this time, but the timing indicators we usually use to get more precise with the "when" part of the equation haven't been a help at all in judging when that is likely imminent.

All the best,