Snapshot Notes - May 5, 2008


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MONDAY, MAY 5, 2008

Breadth Almost as Bad as Volume

05/05/08 9:20 AM EST

As of:

SPX 1375

HELP ARCHIVE

Good Monday morning...We begin the day with a modest gap down in the major indices. The weekend news flow was fairly quiet outside of Microsoft/Yahoo!, and several overseas markets are closed for the day. The ISM data out at 9:00 could be a very short-term market mover if we see a surprise number, but other than that it looks like another slow day ahead.

Over the past week or so, I've been harping about volume, and how it has been so exceptionally low across stocks and ETFs. It was clear from the data we looked at that low volume - particularly during donwtrending markets - was not a bullish phenomenon.

Today I want to touch on breadth. It has not been doing well either, as the major indices have been masking some underlying weakness. We can track that by watching a cumulative advance/decline line - an indicator which simply adds or subtracts the net breadth in an index each day (e.g. if 100 more stocks rose than declined on a given day, then the indicator rises by 100).

The chart below shows a blow-up of the cumulative advance/decline line for the S&P 500 that we update daily.

Unfortunately, I only have data for this going back to 1996. But it was interesting to me that despite the recent breakout to a three-month high in the S&P 500, the underlying cumulative breadth indicator is 13% below its own three-month high. For the Nasdaq 100, it's even worse...there the cumulative a/d line is 25% below its February high.

I was curious to see if there was any other time when the S&P 500 was in a downtrending market (i.e. a downward-sloping 200-day moving average), then it hit at least a three-month high, while at the same time the cumulative a/d line was at least 10% below its own three-month high. That should give us any precedents for breadth divergences during tough market environments.

Of course, the only real tough market since 1996 was from 2000 - 2002, so we're fairly limited. But there were three instances that arose: 05/21/01, 12/05/01 and 11/27/02. The interesting thing about those dates is that all three marked the exact high for the S&P 500 on both a short- and intermediate-term basis.

If we remove the restriction that the market be in a downtrend, then the results improve, but are still lackluster. The one-week return in the S&P averaged -0.3% with 48% of them being positive. That lagged both random one-week returns and those when the a/d line wasn't diverging so badly. After a week so so, returns were more consistently positive, but weakly so - the bull market rolled on, but not as aggressively as when breadth was confirming the price breakout.

Removing the "downtrend" restriction, one-month returns going forward when breadth was lagging badly averaged +0.4%; when breadth was confirming the three-month breakout, then the average one-month return was +1.2%, three times as high.

Like volume, breadth is not a primary indicator for me - it simply helps to flesh out whether we're in a healthy market environment or not, which in turn helps me to determine how aggressive I want to be with long or short setups. Given the very weak breadth we're seeing, the even weaker volume, the general downtrend that remains in place, and the fact that the market has satisfied the suggestions from many of our March studies, I remain concerned about our ability to sustain recent price gains.

From a shorter-term perspective, that means I want to be equally open to short-side setups as long-side ones, giving up the long-only bias I had for much of the spring. So I'll be looking for more evidence that the potential negatives we've discussed are coming home to roost. The negatives have been what I consider minor, but they're really the first negatives we've seen since the March low nonetheless.

For the past couple of weeks, there hasn't been much I've been able to find on a short-term basis that got me excited about trading aggressively. We had a deluge of economic and earnings data last week, and the market responded mostly positively but with some odd moves that helped to confuse the picture. Some of the correlations among asset classes and sectors that had held up for months began to break down, giving me even less confidence in already-questionable setups.

Now that the news flow should be winding down, we'll be able to get a better feel for the actual supply and demand out there, without as much overnight gap risk and knee-jerk reactions. For the moment, I'm still not doing much trading-wise, but continue to have a generally neutral to slightly negative short-term view. What I'm watching most closely is the Nasdaq 100 and Russell 2000, seeing if those indices can break and hold above 2000 and 740, respectively. If they can, then I'll have to re-consider the ability of buyers to hold up this market, but until that happens or we get a better setup among the sentiment-, breadth- and price-based patterns I watch, I think we'll see the recent gains peter out.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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