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Oxford Financial Group, LTD


Oxford Financial Group, LTD


Expert Perspective

News, research and market insights from our team of experts.

Investment e.Perspective

Current Issue | May 15, 2019

Tired Bull

By: Jared Nishida, CFA, Senior Investment Strategist & Oxford Investment Fellow

Editor's Note: Please refer to Mark Green's article for an update on recent volatility.

On August 14, the S&P 500 closed with a year-to-date gain of 2.9%. Elevated valuations coupled with above-average profit margins point toward low to mid-single digit returns from US equities, and that is exactly what 2015 has delivered. The bull market marches on.

On the surface, all is well within U.S. equities – a nice and neat fit of index behavior within the context of a broader narrative of lower expected returns. However, a look beneath the surface at market internals reveals information about the US equity market that is at odds with such a tidy conclusion. From that perspective, the bull market appears to be losing steam.

Market breadth is an indicator that measures the broad participation of an index's individual constituents with what is actually occurring with the overall index. Different versions of market breadth exist but they all attempt to generally capture the number of stocks rising in price relative to the number of stocks falling for a given index. Because the metric excludes consideration of market capitalization, it is not skewed by the size of the company. Is the bull market broad-based and supported across sectors? Is underlying weakness developing as leadership narrows? These are questions that can be addressed through analyzing breadth that are not captured through a basic look at total index levels.

Why does this matter? Market inflection points for broad indices are notoriously difficult to identify ahead of time. While "false starts" can occur with some regularity, a divergence in market breadth from the index is a common feature that often precedes a directional change in the market. It isn't perfect and we don't rely solely on this data point to inform our investment decisions. But, it would also be foolish to completely dismiss information with relevance in past cycles.

Examining current market breadth within the S&P 500 index reveals such a divergence. The graph below includes both the index level and the percentage of index constituents with current prices above their own 200-day moving average. Since May the index has grinded sideways, but market breadth has steadily declined as more stocks fall below their 200-day moving average. The index has become increasingly reliant on a narrowing list of securities to carry the load as fewer and fewer stocks sustain their upward price trend. In May, 75% of the S&P 500 stocks were above their 200-day moving average price compared to just 56% now. This begins to paint a picture of a market that is "internally fractured," to borrow a term from Leuthold Weeden Institutional Research.

Below is the same chart shown prior to and during the Financial Crisis of 2008. In this case, market breadth began to falter in June 2007 but the S&P 500 index didn't show signs of turning over until early 2008.

In each case, market breadth gave an early warning sign that participation in the bull market was narrowing and weakness was developing within the index. It is also evident that this relationship can persist for an uncertain period of time, especially when investors remain infatuated with the market leaders and their strong price momentum.

It is important to remember that starting valuation is a primary way we measure opportunity and risk in portfolio construction. Fundamental valuations act as a center of gravity for prices, and markets tend to mean revert to them over the long term. This is foundational to our core principles, but we recognize it is most effective over long periods of time. In shorter periods of time, valuations that are cheap can get frustratingly cheaper, while high-flying, expensive markets can run, and run and run.

Market breadth – among other indicators (credit spreads, sentiment) – offers a different perspective with more application in identifying shorter-term market drivers. We pay attention to all of these inputs as a group without blindly following any of them individually. In this case, market breadth is giving us a flashing yellow light that complements broader equity valuation concerns.

Tired bull, indeed.

The above article represents the opinion of the author as of 8.25.15 and is subject to change at any time due to market or economic conditions or other factors.