One more sign of dwindling participation

Key points:

• A second component in the Risk-Off Composite Model issued a warning at the close of trading on Tuesday
• The model highlights diminished participation, evident in fewer stocks outperforming the S&P 500
• Similar conditions preceded negative returns for the S&P 500 over the subsequent three months

Fewer and fewer stocks are outperforming the S&P 500

On Tuesday, a new signal from a voting member in the Risk-Off Composite Model issued an alert. The component uses the percentage of S&P 500 members outperforming the S&P 500 over a rolling 21 and 63-day period to identify when fewer and fewer stocks are keeping up with the index, indicating a narrowing in participation from a different perspective than traditional breadth indicators.

The model requires the following criteria to issue an alert:

1. % of S&P 500 members outperforming the S&P 500 over a rolling 21-day period falls below 41.5%
2. % of S&P 500 members outperforming the S&P 500 over a rolling 63-day period falls below 43%
3. The S&P 500 is trading less than 1% below a 252-day high
4. If, within ten days of conditions 1, 2, & 3, the S&P 500 declines below the upper end of its two-month range, an alert is triggered 

Like any standalone indicator, this model is not foolproof, as demonstrated by the two prior alerts that preemptively issued warnings well in advance of corrections. For this reason, I employ a broad composite model approach to managing risk.

Similar periods with dwindling participation preceded negative returns

A decline in the number of stocks outperforming the index tends to result in a pessimistic outlook for the S&P 500 over the ensuing three months. In each time frame within that period, the median maximum loss exceeded the maximum gain. 

A single arrow is easily broken, but not ten in a bundle - Japanese proverb

With the new component alert, the Risk-Off Composite Model signal count increased to 40%. If one more member issues a warning, the composite model would trigger a risk-off signal.

The TCTM Composite Risk Warning Model, designed with big-picture long-term indicators, currently reports a risk level of 10%, comfortably below the trigger point of 50%.

What the research tells us...

Subtle clues regarding the internal strength of the stock market advance continue to emerge, suggesting a backdrop with fewer and fewer stocks participating in the uptrend. The latest indicator to trigger a warning measures participation based on relative performance versus the S&P 500. This system, a member of the Risk-Off Composite Model, registered an alert on Tuesday, indicating the world's most benchmarked index could struggle over a medium-term horizon. While a concern, the weight of the evidence has not overwhelmingly swung to the bearish side of the ledger. For now, we should remain vigilant regarding additional risks.