It's been a great run in stocks from the mid-October lows, fueled by significant buying pressure coming out of those lows. By mid-November, my measures were showing diminished upside momentum, but not the kind of weakness that would normally lead to meaningful intermediate-term corrections. By the end of November, pockets of outright weakness became evident in the market, with smaller cap issues and commodities-related stocks showing particular weakness. This led to a recent situation in which stocks making fresh three-month lows actually outnumbered those making new highs, despite SPX hovering near its all-time highs. Not only have we been seeing signs of weakness within the U.S. stock market; globally stocks have not kept up with SPX.
Recall that I track the number of upticks and downticks across all stocks in the NYSE universe. That buying and selling pressure measure has been quite useful in tracking strength and weakness during the evolution of intermediate-term cycles. What we see in the top chart is that the buying-selling balance has been below zero for a number of recent sessions, a pattern we have seen during the topping phases of market cycles. In itself, that simply indicates a waning of broad buying interest and some pick up of selling, though not to the degree we saw prior to the early October drop.
Truly outstanding has been the plunge in my measure of correlation among stocks, which looks across both capitalization levels and sectors. Indeed, this is the lowest correlation level I have seen since tracking the measure since 2004. Correlation tends to rise during market declines and then remains relatively high during bounces from market lows. As cycles crest, we see weak sectors peel off while stronger ones continue to fresh highs. As those divergences evolve, correlations dip. Right now we're seeing massive divergences, thanks to relative weakness among raw materials shares (XLB), energy stocks (XLE), regional banks (KRE), and small (IJR) and midcap (MDY) stocks. Why is this important? Going back to 2004, a simple median split of 20-day correlations finds that, after low correlation periods, the average next 20-day change in SPX has been -.33%. After high correlation periods, the average next 20-day change in SPX has been +1.43%.
A very interesting sentiment measure that I track is the amount of capital flowing into and out of various ETFs. The number of shares outstanding in an actively traded ETF changes daily, reflecting underlying buyer and seller interest. Trim Tabs follows these ETF flows and notes that we are at extremes that were seen prior to the 2008 market meltdown. My own figures for SPY find that shares outstanding recently have hit double digit increases over the past 20-day period. That reflects bullish sentiment in the top 90% of all values I have tracked since 2006. Going back to 2006, when sentiment has been in the top bullish quartile, next 20-day returns have averaged a loss of -.57%. When sentiment has been in the bottom, most bearish quartile, next 20-day returns have averaged a gain of +1.57%.
I put all that together and find it difficult to see good upside risk/reward from this point. When I saw lack of strength turn into outright weakness in mid-September, my bullish chips came off the table. Now I find myself in a similar mode. Could ECB or the Fed come to the market's rescue and inject fresh catalytic strength into stocks? Absolutely. Could investors pour money into stocks and chase late December seasonal strength? Of course. I am confident those developments will show up quickly in my buying/selling strength measures and I will report them duly. Right here, right now, however, I see global signs of disinflation and economic weakness; a Fed that has been talking about exiting QE; low equity put/call ratios; and persistent relative weakness in high yield bonds (HYG). It will take a fresh catalyst--and fresh evidence of buying interest--to get my chips back on the bull's table.