Thursday, April 09, 2015

Weakening Breadth and Rising Volatility in the Stock Market

Here are the reasons I am cautious about the stock market at this juncture:

1)  We are seeing good buying activity in stocks, as gauged by the NYSE TICK which has been making new highs on a cumulative basis.  Among the large caps (top chart), that buying activity is no longer able to give us fresh price highs.  (Credit for the top three charts to Index Indicators).  Note that breadth in the large caps has continued to dwindle throughout 2015, with fewer 100-day new highs vs. lows.

2)  We have seen greater recent price strength among mid-caps (second chart from top) and small caps (second chart from bottom), as we're hovering near price highs.  Despite this, the breadth specific to mid-caps and small-caps has also been waning, with fewer shares making new highs vs. lows in April than March.

3)  If you look at the cash VIX, it seems as though volatility remains crushed, as VIX is sub-15.  Actual volatility, however, as measured by average true range over a rolling 100-day period, has been higher during 2015 than during the vast majority of the prior two trading years.  Rising volatility in stocks historically has been associated with weakening markets, not strengthening ones.  Indeed, volatility picked up at market highs in 2000 and 2007 well before the subsequent bear markets.  While I don't expect that kind of bear market activity currently, any downside break from here would likely see greater volatility than recent corrections.

I also note that the volatility of realized volatility (vol of vol) has been higher recently than at any time since 2013.  The recent rise in realized volatility and vol of vol helps to explain why short-term traders have had difficulty trading U.S. stocks:  We've had movement, but not trend.  It's been a choppy, volatile range trade.  Buying strength or selling weakness--trading with a fear of missing out--has been a consistent way to lose money.  Viewed on a longer time scale, however, this market appears to be one of narrowing breadth--even among those smaller cap sectors that have been strongest.  That keeps me cautious.

Further Reading:  Macro Themes Impacting Stocks