Breath thrust as long-term momentum reaches inflection point

Jason Goepfert
2020-09-29
Stocks enjoyed a broad thrust on Monday as an overwhelming percentage of securities advanced. Coming off of a pullback within an uptrend, that has been a good sign. The long-term McClellan Summation Index fell below zero, though, which bears watching as momentum ebbs.

On Monday, stocks enjoyed a broad surge. We noted that the Up Issues Ratio jumped above 85%, which is relatively rare in an uptrending market. There are all kinds of securities that trade on the NYSE, and getting an overwhelming percentage of them to point the same way is like herding cats.

Using a lesser extreme for the test, we can see that forward returns were still very positive.

Thanks in part to decimalization, breadth metrics have become more volatile, and so we've seen most of these extremes in just the past decade. Because it was dominated by a persistent bull market, after these signals there were only 4 losses over the next 6 months, and 2 of those were tiny. The risk/reward was heavily skewed to the "reward" side. A year later, there was only 1 small loss out of 26 signals.

The thrust came just as the long-term McClellan Summation Index dropped into negative territory.

The last time the Summation Index cycled from extreme oversold to extreme overbought within a year, then drifted down toward zero was in May 2019. Buying pressure can in soon and the Summation Index never quite made it down to zero. When it did, forward returns were mostly positive and risk was small.

If we ignore the oversold reading and just look for the first dip below zero for the first time in months, following a big overbought reading, then returns were still good.

The Summation Index is one of the indicators we monitor to determine the overall market environment. When it's below zero and declining but not yet oversold, it's the worst possible combination. The only caveat here is that it's been above zero for a long time and coming off a very high reading, showing notable positive momentum. That suggests any dip here could be smaller than usual, and a curl up in the Summation Index would help confirm that.

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