Saturday, July 21, 2007

Cracks in the Market Foundation

I recently mentioned in my Twitter comments that we're seeing a mixture of strength and weakness in the market over the past week. For example, we had 569 stocks making fresh 20-day highs on Wednesday against 1292 new 20-day lows. Then on Thursday we had 1197 new 20 day highs against 642 new lows. On Friday, we returned to 630 new highs and 1287 new lows.

The mix of strength and weakness can be seen in the 52-week data as well. The Dow recently made fresh all-time highs, breaching 14,000. Nevertheless, on Friday we saw 118 stocks on the NYSE make new annual highs and 138 make new 52-week lows. Similarly, the NASDAQ 100 Index has been quite strong, making new bull market highs this week. New 52-week lows among NASDAQ stocks have been leading new highs, however. On Friday, we had 74 annual highs among NASDAQ issues and 194 new lows.

Going back to 2004, I could only find 8 occasions in which a day with over 1000 20-day highs among NYSE, NASDAQ, and ASE stocks was followed by a day with over 1000 new 20-day lows. On five of those eight occasions, the S&P 500 Index (SPY) was lower over the next week of trading. The reason for this is that good bull markets pull pretty much everything off their lows. When averages make new highs amidst many new lows in individual issues, the new highs most often are a function of selective strength among the most highly weighted stocks in the indexes. Most traders don't realize that the largest 50 stocks in the S&P 500 account for nearly 50% of the index's weighting.

When you're as old as I am, you've seen these movies before. From 2/1/2000 to 3/10/2000, the NASDAQ Composite rose almost exactly 1000 points: a 25% move. Out of those 28 trading days, only 14 had more advancing stocks than decliners among NASDAQ issues. In fact, 10 of the last 15 days of that runup (in which we gained over 600 points!), we had more declining stocks than advancers.

And as we were making fresh all-time highs in the NASDAQ? New 52-week lows were creeping higher, exceeding 100 and hitting 20-day peaks on several occasions. The day after we hit the peak in the NASDAQ Composite, we had more annual lows than highs on that exchange.

And how about the market peak in July, 1998? We hit an intraday high--and a high for that bull market--on July 20th. Leading up to that peak, five of the prior nine trading sessions saw more losing stocks than gainers among NYSE issues. At the very peak, we only had 128 new annual highs among NYSE stocks against 73 new lows. The next day, 52-week new lows outnumbered new highs.

Does this mean we're necessarily heading for a bear market akin to July-October, 1998 or the 2000-2002 debacle? Of course not. Rather, my point is that there are cracks in the market foundation. We're seeing a flight to quality in Treasuries, with risk aversion in fixed income. We're seeing a U.S. dollar hitting all-time lows against the Euro--and now even losing some strength vs. the Yen. That's helping us record fresh highs in commodity prices, such as oil, that are denominated in dollars.

And the banks: they dominate the 52-week low list. Financials are hurting, as fears of overaggressive lending are now spreading outside the subprime housing sector.

Yes, you could say it's a wall of worry. The problem is that many stocks are not climbing that wall. We've been up over the past three months of trading. But new 65-day lows currently outnumber new highs by more than 2:1. We've certainly been up in the major averages over the past year. But if we count just the common stocks trading on the NYSE, we find that 84 made new annual highs on Friday and 67 made new 52-week lows. And small caps? We had 14 stocks make annual highs among the S&P 600 issues on Friday against 42 fresh 52-week lows.

Dow 14,000 made a great headline. For my part, I'll keep an eye on that market foundation.