Sunday, May 15, 2016

Seeing Beneath The Market Surface

Markets move higher, markets move lower.  The question worth continually posing is, "Is the market getting stronger or weaker?"  This is a meaningful question because a market that moves higher can be getting weaker and a market that moves lower can be getting stronger.  Perhaps momentum is waning.  Perhaps fewer shares are participating in the move.  Very, very often markets will get weaker before they put in a top and will get stronger before a bottom is in place.  Is the dollar index moving lower?  How many dollar crosses are actually participating in that move?  Are stocks moving higher?  How many sectors are driving the move?  Oil is moving higher.  Are we seeing a growing number of contracts trading at offer vs. bid price, or are we seeing size starting to hit bids?

Long before the tree falls, the trunk has weakened.  Sports teams build rosters before the wins show up on the scorecard.  A political candidate loses support with a couple of constituencies before losing the election.  We look beneath the surface of events to gauge possible directions and outcomes.

Perhaps we seek a long-term romantic relationship.  We are attracted to a person's looks and demeanor, but ultimately we look beneath the surface to determine if the fit is there.  Do they share our values?  Are they caring, responsible people?  Do they complement my strengths or merely compliment them?  What looks attractive is not necessarily a good relationship; what doesn't initially grab us can dazzle us with beauty as we look more deeply.

Too often we focus on price action alone, failing to look beneath the surface.  Stocks in the U.S. are making new highs, but across the globe buying is failing to generate new highs.  We're making new lows on concerns of economic weakness, but commodities are no longer making fresh lows.  When we deepen and broaden our perception, we see what isn't immediately apparent.  The quarterback who sees the entire field is more likely to make the right decision than the quarterback with tunnel vision.

When we plan a trade and ground ourselves in that plan, we can unwittingly create tunnel vision.  When we develop conviction in a view, we can blind ourselves to fresh evidence that contradicts that view.  Having multiple lenses by which we can view strength and weakness allows perception to stay fresh.

Below we see a moving average-based measure of breadth among the FTSE 100 stocks.  (Raw data from Index Indicators).  We can see when breadth strength leads to higher and lower prices and vice versa.  We can see most recently that buying activity has barely moved shares higher--a distinct change from action since February.  That same shift can be observed among DAX 30 shares and SPX 500 stocks.

But only if we take the time to step back and look at markets afresh, from multiple perspectives.

Further Reading:  Creativity is the New Discipline