Volume has picked up during the recent downturn. No, we are not talking about trading volumes; we are talking about the volume from your TVs with talking heads warning about an impending stock market downturn. If you turn off the TV and focus on what the market is telling you, rather than the talking heads, you can tune out the noise. The way we listen to the market in our investment process is through technical analysis, where we assess the behavior of the market and its underlying drivers. Analyzing market breadth has been an especially useful technical analysis tool for predicting recessions and bear markets. There are various ways to look at market breadth, and we will be looking at two critical areas in this week’s commentary.
Market breadth can be tracked by looking at the number of stocks that are advancing less those that are declining. Tracking how many stocks are taking part in a rally or sell-off can help determine how broad the rally is and how durable it may be. A market that is rising on the strength of fewer and fewer stocks is more vulnerable to a decline. Conversely, a market that is rising with a majority of stocks also increasing suggests underlying strength. Technical analysts typically use the NYSE Composite when analyzing market breadth because of its large number of constituents. If market breadth begins to decline and diverge from the rise in the NYSE Composite Index and then the index starts to decline, it signals that the market has become more vulnerable to further declines.