The first trading day of 2022 was promising for the stock market: The benchmark S&P 500 Index made a new all-time high.
It’s been downhill ever since.
Rallies in March and May fizzled, and were followed by lower lows, a bad sign. It took until June for the cumulative decline in the index to exceed 20%, meriting a “bear market” label.
But such thresholds are arbitrary and can add more confusion than clarity. Beneath the surface, there has been downside pressure in stocks that stretches back into 2021.
Stocks are now putting together their lengthiest rally attempt since peaking in January. The March rally was more intense — 11% vs the current 8% — but lasted only 11 trading days versus the 20-plus days since the mid-June lows. This is raising expectations that a sustainable move higher may be emerging. Perhaps a new bull market is already in the process of being born.
Skeptics warn that some of the most intense rallies occur in bear markets. The experience in March — four consecutive gains of 1% or more on the S&P 500 — echoes that. Just looking at the magnitude of the price moves can make it difficult to distinguish between signs of durable strength and evidence of a volatile market. In March, it turned out to be more of the latter.
Surging upside volume bolsters the view that a sustainable move higher may be in the works. This is especially positive now because it was notably absent in March.
On Friday, July 15, “up” volume outpaced “down” volume at the New York Stock Exchange by better than 9-to-1. Two trading days later — July 19 — up volume outpaced down volume by over 14-to-1.
The March rally failed to produce even a single 9-to-1 up day. We did get a single 9-to-1 up day in May, but multiple 9-to-1 down days soon followed.
History suggests that seeing two days of better than 9-to-1 upside volume without an intervening down day is an indication that downside momentum in the market has been broken. In order to start going up, the market first needs to stop going down.
While an encouraging step in a positive direction, this does not provide an all-clear signal. An upside volume thrust is just one of five indicators on the checklist — posted above — we have been leaning on to facilitate an emotionless distinction between volatility and strength. It tends to be the earliest to improve, but can also be the most prone to reversal — a couple of days of intense selling can reintroduce downside momentum.
A durable move higher is unlikely while conditions beneath the surface remain challenging. While the new-low list is shorter than in recent weeks and months, it is still longer than the new-high list.
On a weekly basis, NYSE plus Nasdaq new 52-week lows have outnumbered new highs for 34 weeks in a row — this is the longest stretch since the financial crisis almost 14 years ago. Even as upside volume has surged and prices have rallied, we have continued to see more new lows than new highs on a daily basis.
The 74 days in a row of more new lows than new highs on the Nasdaq is the longest streak in more than two decades. Our net new high advance/decline line (which measures the cumulative number of new highs minus new lows on the NYSE and Nasdaq) has been trending lower since November.
While some may see these as wants rather than needs or expect improvement to come along later, the reality is that all of the net gains in the S&P 500 SPX, -1.15%, Nasdaq Composite COMP, -1.87% and Russell 2000 RUT, -0.69% over the past 20-plus years have come when more stocks have been making new highs than new lows.
Our risk indicator looks at the relative price performance between pairs of assets within, and across, asset classes. It objectively measures risk appetite. Since early this year, it has been decisively signaling a risk-off environment.
While a shorter-term version of this indicator has peaked into risk-on territory, strength has never been persistent enough to get the longer-term version to cross the threshold. A sustained rally is likely to produce a healthy appetite for risk that is evident across the board.
The most durable of the indicators on our checklist may be new 20-day highs on the S&P 500 spiking above 55%. (This indicator has been attributed to Jeff deGraaf.) This produces a breadth thrust that creates a favorable regime lasting a year. This indicator has signaled breadth thrusts on 26 occasions since 1976. In only one instance were stocks lower a year later, and the market returns during these regimes has been twice the average across all periods.
We don’t have the gift of foresight, and we don’t know what the future will bring. But we do have evidence from the past to help inform our present conclusions. The world is a dynamic place, and we need to be willing to adapt.
As Keynes once wrote, “when my information changes, I alter my conclusions.” As evidence turns to signaling a more favorable environment has emerged and that a new bull market is under way, we will lean into it. We took a step in that direction last week, but there is still more work to be done.
Willie Delwiche is an investment strategist at All Star Charts, where he leads the ASC+Plus service designed for financial professionals. Follow him on Twitter.
