You could look at a million data points when analyzing markets. But should you? Do you need to look at everything before you invest?
After studying history, I came to a surprising conclusion... Most information isn't worth worrying about... because it's already factored into prices.
So simply following prices and trends will tell you what you need to know.
When prices are rising, we don't need to know why. Rising prices tend to keep rising – that's what matters.
Even so, we never approach markets blindly, because metrics beyond price can show us what's happening below the surface.
Today, we're taking a look at some of those indicators. Signs of weakness have been brewing in recent weeks. And they call the market's health into question.
As I'll explain, if these problems aren't resolved, they could bubble over into a market-moving event...
The Market Is Hitting New Highs... But Most Stocks Are Falling
When we discuss the health of the market, we're looking at "market breadth." This tells us whether more stocks are moving higher or lower.
Normally, breadth indicators rise and fall based on the market's trend. When prices are rising, breadth tends to be strong. When prices are falling, it tends to weaken.
So most of the time, you can focus on prices and ignore market breadth altogether. But when prices and the market's trend diverge, you need to pay attention. And now is one of those times...
The S&P 500 Index has rallied to all-time highs in recent weeks. But fewer and fewer stocks are joining the rally. We can see it in a few different ways...
First is the advance/decline line for all New York Stock Exchange ("NYSE") listings. This line takes the number of stocks that rose on the day and subtracts the number of stocks that fell. Then it adds that number to the previous day's reading.
Over time, that builds a cumulative series. When most stocks are rising, the advance/decline line rises, and vice versa. But despite the overall market's rally, the advance/decline line has moved lower in recent weeks. Take a look...
This is the kind of divergence we should keep an eye on. The market is near highs, but more stocks are falling than rising. That means only the biggest stocks are propping up the rally... a worrying sign.
It Pays to Watch the Trends
Another way to see breadth is to look at the percentage of stocks that are in uptrends...
We want to see lots of stocks trading above their 200-day moving averages (200-DMAs). A moving average smoothes out daily noise by tracking the rolling average of prices over a given period. The 200-DMA measures the long-term trend.
With the market near highs, we'd expect most stocks to be trending higher. But as the next chart shows, that's true of less than half of NYSE-listed stocks today...
This shows the same divergence as the advance/decline line – and that's a worrying sign. The overall market is trending up, but most stocks are down. That signals weakness below the surface.
The last measure of market breadth we'll look at is how many stocks are making new highs versus new lows...
Specifically, the next chart divides the number of NYSE stocks making new 52-week highs by the total number of new highs and new lows.
If this indicator is at 1, it means stocks are only making new highs. If it's at zero, they're only making new lows.
This indicator recently fell to just 0.11 – which means many more stocks are making new lows than new highs.
You'd expect that to happen during a sell-off or a bear market... But it's unusual with the S&P 500 near record highs.
These three indicators paint a worrying picture. So what do we do now?
Well, simply put – we don't need to do anything. Here's why...
Understanding breadth is valuable. But it doesn't change the fact that prices matter most. As long as prices are moving in our favor, the underlying issues shouldn't change our decisions.
However, it's still important to know that market breadth is weakening. It means we should be cautious when looking for new opportunities... or moving on from old ones.
In short, this is a yellow light, not a red light.
This kind of situation can end in one of two ways: Either breadth "catches up" and stocks rise to new gains... or the market "catches down" and weakness spills into overall prices. Both outcomes have happened throughout history. Neither is certain from here.
As investors, we want to continue to profit from the current boom. But we also don't want to be blind to its problems.
We'll be watching this story closely in the weeks ahead.
Good investing,
Brett Eversole
Further Reading
Longtime readers know we always follow the trend... but that doesn't mean the market is perfectly efficient. If stock prices included all available information immediately, it would be impossible to outperform. One set of world-class software tools turns the "efficient market" theory on its head.
For investors, caution is a cardinal virtue – especially when it comes to market bubbles. But while most people agree that an AI bubble is forming, history tells us it could be months or even years before it pops.