Something must be wrong…

There may be an illness circulating.

That was my thought when several family members didn’t show up to the Thanksgiving party last week.

And sure enough, it was true. That also seems to be the case for stocks right now.

You see, when stocks are missing from the S&P 500’s rally, it’s a sign something is wrong… that an illness is spreading throughout the stock market.

I’m referring to participation in a stock market’s trend known as breadth – a way to measure how many stocks are joining an underlying move in the market.

Since finding a low in October, the stock market has rallied nearly 11%.

But breadth deterioration is a warning this party won’t last…

Is the Crowd Keeping Up?

Breadth measures how well the average stock among the crowd is keeping up with the major indexes.

A healthy market advance is marked by broad participation, while you should be concerned when fewer stocks are supporting a rally.

For example, take the dwindling breadth leading up to this year’s bear market…

At the start of 2021, more than 80% of stocks across the major exchanges were trading in uptrends. But at the end of the year, that number shrunk to just 42% even as the S&P 500 was making new highs.

That wasn’t a good sign back then… ultimately giving way to this bear market.

Breadth also flagged two other waves of selling this year.

Here’s one metric I’m watching, and why warning signs are flashing again…

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Falling Participation

This bear market has seen three rallies of 11% or more in 2022. But the last two rallies eventually failed and saw the S&P 500 collapse to new lows.

And right before each turn lower, declining participation provided advance warning… and that’s what we’re seeing yet again.

One way I measure breadth is with the McClellan Oscillator.

This figure takes the difference between advancing and declining stocks on the New York Stock Exchange (NYSE), and then averages the difference over a trailing period so we can see how breadth is evolving over time.

Now take a look at the chart below of the S&P 500 (top panel) and the McClellan Oscillator (bottom panel)…

Chart

The red circles show where participation is falling as the Oscillator makes lower highs.

The first two circles on the left marked the end of bear market rallies, and the S&P went on to new lows.

That’s my concern with the red circle on the right, which shows breadth deteriorating even as the S&P 500 is moving higher.

It’s not just breadth indicators that are suggesting a cautious approach…

My colleague Jeff Clark showed you yesterday how several other sell signals are piling up as we head into the new year.

While the financial talking heads seem eager for a rally, Jeff warns that traders should be cautious in the weeks ahead.

So be careful hanging around the stock market’s party for too long as signs of illness emerge, lest your portfolio catches a bug.

Best regards,

Clint Brewer
Analyst, Market Minute

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