Models and Weekend Video – Breadth Model Flips as Participation Widens and Yields Spreads Plunge

Stocks extended their post-crash surge and this week’s advance was enough to break the bear’s back. Today we will look at three trend indicators that turned bullish for SPY, a turn in the Index Breadth Model and update the key breadth charts. We will compare trend signals in February 2019 and October 2007, and finished with the plunge in yield spreads.

It was a big week on Wall Street as stocks surged with the biggest weekly gains since the initial lift off started (late March and early April). Small-caps and mid-caps led the way with gains exceeding 8%. Large-caps lagged as SPY gained a measly 5% and QQQ advanced a paltry 2.71%.

These moves triggered bullish signals on the Index and Sector Breadth Models, and both are now firmly bullish. The Index Breadth Model flipped from bearish to bullish while the Sector Breadth Model moved from slightly bullish to firmly bullish. Among other things, a plunge in investment grade and junk bond spreads fueled the rally.

3 Trend Indicators to Watch for SPY

The chart below shows SPY with three trend indicators. The Keltner Channel (125,2,125) is in blue on the price chart and SPY moved above the upper line this week. The first indicator window shows StochClose (125,5) moving above 60 on May 21st and the lower window shows the percentage difference between the 5-day SMA and 200-day SMA. This indicator turned positive on May 29th, which means the 5-day SMA moved above the 200-day SMA. Thus, all three of these trend indicators are bullish.

These trend indicators also provide clear signals to watch going forward: a move below the lower Keltner Channel, a StochClose move below 40 and a 5-day SMA move below the 200-day SMA. A clear signal would emerge should two of the three trigger. At this point, a close below 280, which would take a 12.5% decline from current levels, would break the lower Keltner Channel and likely push the 5-day SMA back below the 200-day SMA.  

The chart above was created with Optuma because I am using some indicators not available on StockCharts. The chart is linked to a comparable version from StockCharts. Note that the Keltner Channel is based on a 125-day EMA and it will rise/fall along with prices. The upper and lower lines are set two ATR(125) periods above and below the EMA.

Now what?

The weight of the evidence is bullish. This means I will be looking to increase risk by looking for bullish setups and signals as they unfold. There are not very many, if any, right now because the market is in the middle of its tear. The February high is acting like a magnet for the S&P 500 and the bulls are hearing its siren song. As with October 2007 and April 2019, the S&P 500 could tag a new high and then pullback. The pullback in October 2007 led to a bigger reversal, while the pullback in May 2019 amounted to a garden-variety correction. There will be a pullback or correction at some point and the first one will offer a lower risk opportunity. These are both discussed in today’s video.

Top Ranked ETFs

The image below shows the top 23 ETFs ranked by StochClose (125,5). Notice that the current values are above 80 for these 23 and this means they are close to six month highs because StochClose covers 125 days. Seven ETFs recorded new highs and they all came from the Technology sector (QQQ, BOTZ, SOXX, IGV, FDN, HACK). Healthcare related ETFs also remain strong with XLV, IHI, IHF, IBB and XBI in the top 20. I choose 23 because note that the Retail SPDR (XRT) and High-Yield Bond ETF (HYG) have StochClose values above 80 and are also showing strength/leadership.

You can read more about the methodology behind StochClose and the ETF rankings in this detailed article with lots of chart examples.

StockCharts Index Breadth Model Turns Bullish

The Index Breadth Model turned bullish as the percentage of stocks above the 200-day EMA for the S&P 500 and S&P MidCap 400 moved above 60%. Five of the nine indicators are on active bullish signals and this reverses the bearish signal from February 26th. It was one heck of a round trip as SPY closed just above its February 26th close. MDY remains just below this close and IJR is still around 4% below.  

The chart below shows the 10-day EMAs for Advance-Decline Percent surging above 30% again this week. This is the fourth cross above 30% for the S&P SmallCap 600 and S&P MidCap 400, and the second for the S&P 500. Note that two crosses in three days only counts as one for SPX.

The High-Low Percent indicators are in positive territory as new highs continue to outpace new lows. However, the total number of new highs continues to underwhelm and these indicators have yet to clear +10%. The High-Low Percent indicators have the most lag of the three breadth indicators. A stock will clear its 200-day first and then hit a new high should the advance continue.

The %Above 200-day EMA indicators continue to improve with the S&P 500 nearing 50%, the S&P MidCap 400 hitting 40% this week and small-caps exceeding 30%. Despite these improvements, the cup is still half empty for the S&P 500.

The image below shows the Index Breadth Model signals over the last five years. It looks like another “V” reversal on the price chart. The last V extended from October 2018 to February 2019 (~4 months). The current V started in late February and extended a little more than 3 months. These bear markets are getting shorter and shorter.

As with all trend-following signals, we never know which signals will result in whipsaws (bad) and which will lead to extended trends (good). The signal is the signal and remains valid until proven otherwise.

Click here for an article and video explaining the indicators, signals and methodology used in the Index Breadth Model. This article also includes the signals of the last five years.

3 Indicator Strategy for SPX Turns Bullish

I tested a 3 indicator strategy for the S&P 500 on Friday and results since 2001 were quite good. The returns matched buy-and-hold, despite being invested just 67% of the time. The drawdowns were also much better than three big drawdowns in SPY over the last 20 years. This system also triggered bullish as two of the three indicators crossed their bullish thresholds and the 5-day SMA of the S&P 500 is above its 200-day SMA. I added a simple timing mechanism to soften the blow of bad breadth signals and the system turns bearish when two of three indicators trigger bearish OR when the 5-day SMA moves below the 200-day SMA.

Sector Breadth Model Turns Very Green

There were eight new bullish signals on the Sector Breadth Model this week. Most were with the %Above 200-day EMA indicators. There was one bullish signal in High-Low Percent (XLK) and one bullish breadth thrust (XLRE). All told, 9 of the 11 sectors are net bullish and 23 of the 33 indicators are on active bullish signals. Perhaps most important, the Finance, Consumer Discretionary and Industrials sectors joined the party and turned net bullish as the percentage of stocks above the 200-day EMA expanded sharply this week.

Yield Spreads and Fed Balance Sheet

Investment grade bond spreads fell further this week and moved below their 2019 highs (pre-crisis highs). This means the high end of the credit market is back to levels before the covid-19 crisis. BBB spreads fell sharply and are nearing their pre-crisis highs, which is bullish for credit and for stocks.

Junk bond spreads fell sharply as well and are nearing pre-crisis levels. Junk bonds are more like stocks than Treasuries because they benefit from a growing economy and easy monetary policy. The plunge in junk bond spreads means borrowers can tap the credit markets at lower rates and pay less to service their debt. The plunge also means the junk bond market is nearing normalcy as the spreads near pre-crisis levels. The CCC spread is still well above pre-crisis levels, but it fell the sharpest of the spreads this week and is moving in the right direction.

The Fed balance sheet expanded by a measly $68 billion this week. Such an increase would have been BIG in September, but it is just a drop in the bucket after the HUGE weekly numbers in March, April and May. The balance sheet continues to expand at a rapid rate and this money is finding its way into riskier assets, such as junk bonds and stocks.

Thanks for tuning in and have a great weekend!

-Arthur Hill, CMT
Choose a Strategy, Develop a Plan and Follow a Process

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