Discover more from fx:macro
[FREE] fx:macro Lite / 05.11.23
Rain, umbrellas and Greek temples
Hi there! It's already Sunday, so it's time for another edition of fx:macro Lite! Great to have you here!
When I asked MidJourney for a cover image for this issue, I put in the prompt: “What breadth looks like in the stock market”. The results look weird but some things came up again and again: rain, people with umbrellas, and parts of Greek temples or pyramids.
This week, I write about how I approach market breadth and why it's valuable. And in a sense, MidJourney captures quite a few relevant concepts in its images. You can read more about that below.
Let's get started…
In case you missed the usual deep-dive yesterday, you can still sign up for that here and get access to the premium content:
💎 Three central banks and three PMIs
In a sense, reading “old” central bank statements and comparing what they said this time around to what they said before, feels like reading yesterday’s newspaper. But I think it’s just basic homework for everyone who’s seriously trading currencies. This week, homework means: Fed, Bank of England and BOJ.
🎄 What about year-end seasonality?
Here’s what I think from this week’s issue of fx:macro Premium
You can sign up by clicking on the button below:
💡 Market Breadth
I guess most of you are familiar with the basic idea of market breadth. If not, here's a quick explainer from ChatGPT:
Stock market breadth is a term used to describe the extent and direction of participation of individual stocks within a broader stock market index. It provides insights into the overall health and sentiment of the stock market.
The S&P 500 is capitalization-weighted, so a small number of companies have a disproportionally large influence on the movement of the entire index. MSFT 0.00%↑, AAPL 0.00%↑, AMZN 0.00%↑ and NVDA 0.00%↑ alone make up 20% of the entire S&P 500. That's nothing new but it's always a good reminder…
Market breadth removes that bias as it gives each stock the same weight. Here's what that looks like when we compare the SPY 0.00%↑ with the equal-weighted RSP 0.00%↑. Not much of a difference in how they trade overall, and they're taking turns in which one outperforms the other.
It's not the go-to indicator I'm looking at because it essentially tells you how small(er) large caps perform vs. a few mega caps.
📊 The Classic - Advance/Decline Line
Another popular indicator (and one of my favourites) is the advance/decline line. It looks at how many stocks are up vs. how many stocks are down and takes a cumulative sum of the difference:
Things get interesting when there's a divergence going on. Here are two examples:
Right at the beginning of 2022, the SPX made a final push higher but the A/D line put in a lower high at this point. A few months later, the SPX made a new low but the A/D line wasn't following and made a higher low. There are a lot more examples of relevant market tops that were preceded by the A/D line warning you beforehand, here's September/October 2018:
It's almost as if it hands you an umbrella when it's about to start raining (thanks, MidJourney!).
As always, it's not 100% perfect:
You can find plenty of market tops where breadth did not ring the alarm, so:
A market going up together with its A/D line, or
A market going down with the A/D line going down as well isn't very interesting from a breadth perspective, and breadth is not “supporting” the market… it just does what it normally does.
On the other hand:
A market going higher with the A/D line declining, or
A market falling with the A/D line going up are both times to pay close attention.
Usual disclaimer here: it's not a 100% sure thing. Just look at the most recent example from around June-July this year: the A.I. mania was in full force and a few tech stocks pulled up the S&P while the A/D line initially didn't follow.
So, don't treat it as a religion (H/T the Greek temple from MidJourney). But if you go back, you'll find a lot more examples of it working than not.
😱 The Panic Indicator - Stocks above their 50 DMA
Another indicator I follow closely is the number of stocks above their 50-day moving average. Here's what it looks like for the Nasdaq 100:
That's a nice way to look out for market bottoms: when only around 10% or fewer stocks are trading above their 50 DMA then it's often a good time to start paying attention. I've marked three occasions in the chart above:
March 2020: The reading almost reached zero, and it remained low for a month or so.
March 2021: A relatively small market correction, the indicator did not reach the 10% mark but the -2 SD band I put around it.
October 2022: the most recent market bottom with a reading of almost zero again.
Since it's impossible to know how long the indicator can stay depressed, it's impossible to catch the exact low. I tend to look at it on its way up again: as soon as it reaches the 50% mark or the -1 SD band, a bottom is probably in place.
The number of available indicators is endless… New Highs vs. New Lows, Advancing vs. Declining Volume, McClellan Oscillator and so on. I tend to stick with the two I showed above but that's just personal preference.
Good signals don't come often no matter which indicator you choose. The A/D line can go a year or longer without giving you any useful information, and if you look at the last screenshot above, you can see that meaningful downside spikes in the number of stocks above their 50 DMA aren't that frequent either. That's why it pays to have a routine in place where you look at the same charts over and over again.
Let me know what you think!
Until next weekend