That being said, the ferocity of this rally has taken many traders by surprise, and that certainly includes me. My most recent look at market breadth suggested that market strength was actually expanding, not contracting as it had done from much of June through September. I suggested some give back was to be expected, as many of my measures were approaching levels associated with past momentum peaks, but the news from Japan on Friday only lifted stocks further.
Meanwhile, correlations and volatility remain high--not what we normally see when rallies are sputtering and about to turn over. We are accustomed to seeing stocks fall on increases in volatility and rise on decreasing volatility. In terms of realized volatility--not the implied volatility measure of VIX--this has not been the case. We have rallied on actual price volatility that is much greater than would normally be expected at the current level of VIX.
While there are clear risks to assuming "this time is different", there are also risks in assuming that the future will faithfully replicate the past. This rally has not been replicating recent ones, and that is why I and others have been surprised. In the past, a several day pullback during an uptrend has provided a reasonably good risk:reward entry for traders wanting to ride the trend. Waiting for the pullback in the current market would have meant missing the rally altogether. Short-term overbought levels have stayed overbought far more persistently than usual. To give but one example, we have had 11 straight trading sessions in which more than half of all SPX shares have closed above their three-day moving averages.
The above charts puts this rally into perspective. Note the cumulative line of upticks vs. downticks for all NYSE stocks (top chart) and for all stocks trading on U.S. exchanges (including NASDAQ, NYSE MKT LLC, and regional exchanges). In both cases, we see a dramatic turnaround and persistent buying across the broad range of shares. Interestingly, the broadest measure of TICK, representing all U.S. shares, has made the strongest comeback, reflecting renewed buying interest among smaller cap shares, which had been laggards.
The bottom chart shows the explosion of stocks making new three-month highs vs. lows across all U.S. common stocks. When looking at 52-week new highs/lows, that measure is the strongest we've seen since late 2013. This reinforces the earlier conclusion that the current market has been gaining strength, not topping out.
In short, the data support the notion that this is a fresh bull market leg, not a bounce in a topping market. If that is the case, we can expect further price gains, even after momentum has crested. I will be tracking the above measures and others to update the rally's trajectory.
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