Can You Have Too Much of A Good Thing?

One of the best tools in a technical analysis toolbox (at least in my opinion) is breadth data, which allows an analyst the ability to look at the individual stock participation of a trend, whether it’s up or down. At the end of the day the stock market truly is a market of individual stocks and when the majority of them are moving in one direction, there’s a strong chance the broad indices will follow. By understanding the ‘health’ of trend based on the high or low level of stock participation we can get a good idea if that trend is strengthening or weakening.

One of the methods of analyzing breadth of the market is reviewing the percentage of stocks above a specified moving average. There’s no golden rule here or secret sauce for which moving average to be used, each has its purpose and usefulness based on the time horizon of the user. Personally, I often look at the % above the 50-day and 200-day MA. The more stocks above these moving averages, the more stocks that are likely in up trends – giving bullish support to the up trend of the market itself.

However, is it possible to have TOO many stocks supporting the market?

This is a question I don’t believe I’ve seen many others ask and it’s something I’ve written about in my weekly Thrasher Analytics letter (to learn more and subscribe go here). I believe the answer is yes, just like candy… too much of a good thing can sometimes be bad. Let me explain.

As the U.S. equity market recovered from the March covid crash, more stocks have been rising and adding to the supporting breadth profile of the market, that’s a good thing! We’re now at the point where almost all stocks are back above the 200-day moving average. Again, that’s not terrible news, we’d rather see this number increasing than decreasing! However, at some point it gets to be that there’s few stocks left to flip from down trends to up trends, acting as a propellent to send the market higher.

Think of a group of kids wanting to make big waves in a swimming pool. Each jumps in, causing their own little wave. As each cannonballs into the water the waves in the pool get bigger and bigger. But once they’ve all jumped in, there’s no one left to add to the motion of the water and eventually the lack of catalyst sends the pool water back to a placid state. That’s what we could see occur in equities with few stocks left to hop over the long-term 200-day moving average.

Right now more than 87% of the S&P 500 is trading above the 200-day MA but the individual sectors have an average of 89% of their stocks above the 200-day (excluding energy, if we include energy its 85%). This is the highest average since 2013.

So what’s the big deal?

Well rarely do we have 5 sectors with more than 90% of their stocks above the long-term moving average. The last time this occurred was after the mini-melt up in January 2018 and before that it’s occurred just three times since 2011. Each of these periods, where metaphorically everyone had already “jumped into the pool,” left little catalyst to give the market its next leg up and instead we say varying degrees of weakness enter the market. Most were not severe, remember in early 2018 we had a swift 10% pullback and then continued higher.

There are several other important developments happening below the surface of the market right now, I wrote about several of them in the last two Thrasher Analytics letters, some bullish and some bearish, based on time horizon. I wanted to write about this specific one though as I think it’s a really interesting chart and one I don’t think many technicians have looked at before.

Bottom line, the high level of stocks above the long-term MA is long-term positive, it shows most stocks are in up trends. But short-term, I think it creates a possibly poor risk/reward environment, not necessarily a bull-market up trend-ending decline but some kind of pullback would not be a big shock at this point in the current trend.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.