The Stealth Correction of 2015: A Red Flag for the Bull Market

On the surface, things don’t look too bad in the stock market. The S&P 500 index is down only about 2% from its all-time high. But if you look under the hood, all is not well. In this article, we’ll take a look at participation metrics, which allow us to look beneath the surface and see the number of stocks in the S&P 500 that are actually rising with the overall index.

In a healthy bull market, we expect to see broad participation of individual stocks. That’s not what we have today. Instead, fewer and fewer stocks are generating most of the market’s gains. They’re doing all the heavy lifting.

In other words, the major averages have remained relatively stable simply because a handful of market-beating stocks and industries are pulling the major averages higher. But the truth is there’s a stealth correction going on.

You can see this phenomenon when you look at the percentage of stocks in the S&P 500 index that are currently trading above their respective 50-day moving averages. As it stands right now, about 48% of the stocks in the index are trading above their 50-day moving average. This means the majority of the 500 biggest and best companies on the market are trending lower and already in correction mode.

This is a sign of weak market breadth, a participation metric that indicates how many stocks are moving higher versus how many are moving lower. Right now, breadth is deteriorating, which increases the risk of a more significant correction in the near future. Last week, for example, only 28 stocks on the New York Stock Exchange (NYSE) hit one-year highs, while 158 hit one-year lows.1 That’s a downside ratio of almost 6 to 1.

The NYSE cumulative advance-decline line, another common measure of breadth, is also showing weakness. This line moves higher when the number of stocks on the NYSE that closed higher is above the number of stocks that closed lower.

The NYSE advance-decline line has been dropping since April, and has recently reached its lowest level in six months. It has also fallen below its 200-day moving average for the first time since 2011, the last time the stock market suffered a significant correction. This is another big sign of deterioration in the broader market.

And it increases the odds for bigger losses in popular stock indexes. This kind of weak market participation tends to anticipate big market declines. For example, the NYSE advance-decline line crossed below its 200-day moving average at the end of 2007, way before the market plunged in mid-2008. It’s a red flag for the current bull market.

What Should We Make of All This?

The fact the majority of stocks are in a downtrend means that only certain sectors of the market are performing well. While the S&P 500 index is barely up so far in 2015, other sectors are up by double digits. The only way to outperform the market is by focusing on those sectors. So, which sectors are doing well? Which ones are underperforming?

Cyclical consumer goods and services (also known as discretionary), healthcare, technology, finance and consumer staples are leading with uptrends. While the index is basically flat this year, discretionary and healthcare, for example, are up 10% and 10.4%.

The industrials, energy and materials sectors are lagging with downtrends. These sectors with a strong link to commodities have been quite weak lately due to dollar strength. The losses in the energy (down 14.5%) and materials (down 6.2%) sectors are particularly large. So if you have tons of exposure to these sectors, chances are you are underperforming the market.

Looking at the big picture, it’s important to keep in mind the overall market remains in a long-term uptrend. The fact that some participation metrics are weak is not a reason to panic. But the current weak market breadth is reason for caution.

If participation continues to decline, we could see a more significant correction in the entire market. For that reason, it’s important to keep focusing on the sectors that are outperforming and reducing exposure to the weakest ones, while maintaining a well-diversified portfolio. That’s a good way to manage risk during these volatile times.

Until the next Daily Pfennig® edition…


Tim Smith
Vice President, World Markets Sales and Servicing Trader
EverBank World Markets, a division of EverBank