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Right around Thanksgiving, the S&P 500 quickly dropped 5%-plus in just nine trading days. That move spooked a lot of investors.
Some Wall Street analysts pointed out that stock market breadth had been weakening. While the S&P and Nasdaq are up more than 23% so far this year, the number of stocks in the indexes trading above their 50-day moving averages has been trending lower. That’s what market technicians call bad stock market breadth.
For instance, the average stock in the Nasdaq 100 index is down nearly 17% from the 52-week high price, while the index itself is down only 5.5% from recent highs.
Bad market breadth can be a sign of a deeper market decline to come.
But the good news is, stocks quickly stagged a massive reversal of fortune to the upside. Take a look…
During the recent pullback, the percentage of S&P 500 stocks trading above their 10-day moving averages slumped to just 5%, according to analysts at SentimenTrader.com.
But then it quickly reversed to the upside, with a staggering 89% of stocks trading back above that short-term moving average just five days later.
This is what’s called a breadth thrust. Such a big reversal of fortune is a rare event. And it’s a very bullish one for stock returns going forward.
In fact, three months after past breadth signals, stocks were up 73% of the time and posted median gains of 4.9%. One year later, stocks were higher 81% of the time with 12.3% median gains.
Even when this signal didn’t work in the past, the biggest drawdown for stocks over the next year was less than 10%. That’s a lot like the short-term corrections we have experienced over the last year or so.
Another Bullish SignDespite the recent market downdraft, our own TradeSmith Market Outlook has been solidly bullish too.
And if you drill down a bit deeper inside the S&P 500 Index, it gives you a great reading on the internal breadth of the market too.
In fact, 10 out of the 11 S&P 500 sectors have more stocks in the Green Zone than in the Red right now. And for most sectors, it’s not even close, as you can see below.
Seven out of the 11 sectors have 70% or more of their component stocks in the Green Zone.
Real Estate (XLRE) and Financials (XLF) are leading the pack right now, with 96.6% and 91% of stocks in the Green Zone, respectively.
The lone laggard is the Communication Services Sector (XLC). It currently shows just 26.9% of symbols in the Green Zone with 53.9% in the Red.
The poor performance of the communication sector is most likely due to several large-cap old-timers, including AT&T (T) and Verizon (VZ), that have struggled this year. Both stocks are in the Red Zone and trending lower.
Also, we received a great mailbag question concerning our recent articles on Chinese stocks listed in the U.S. The reader asks about trading put options on these stocks. A long put option could be useful as a hedge against more downside in these stocks if you own them. On the other hand, a short put option is a way to earn income by selling the put to open and collecting the premium. But the risk is that if the stock drops lower in price, you could have the stock put to you at a loss. So be careful with that.