Tuesday, November 04, 2014

Breadth, Sentiment, and a Look at Recent Market Extremes

Here are two charts that display the extremity of the moves we've recently seen in the U.S. stock market.  The top chart shows the percentage of SPX stocks that close each day above their 20-day moving averages.  (Data from the Index Indicators site).  Notice how deeply oversold we became at the October lows and the sharp breadth thrust upward we've seen since then.  More than 90% of all stocks in the index are now trading above their 20-day averages, the highest level we've seen in 2014.  That is not what we'd expect from a weakening market.

The bottom chart displays a five-day moving average of the equity put-call ratio across all options exchanges.  (Data from e-Signal).  Again notice how extremely bearish sentiment became at the October lows and how quickly we've snapped back to normal sentiment levels.  

In general, sentiment tends to hit a bullish extreme prior to price highs during intermediate-term market cycles, and breadth also tends to crest ahead of price.  Given that we have seen strong upward momentum lately, my expectation is that a price peak for this cycle still lies ahead of us.  While sentiment is nowhere near as bearish as it was at the middle of last month, neither is it at a bullish extreme, despite the recent strength.

Further Reading:  Perspective on the Market Rally