By Willie Delwiche
“Gradually, then suddenly.”
This was the answer Mike gave to the question about how he went bankrupt in Earnest Hemingway’s “The Sun Also Rises.” It’s a good way to think about how any change occurs when viewed without proper perspective.
In the stock market, themes that first emerged over the second half of 2021 persisted for the first half of 2022. Even though the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +1.54% closed at an all-time high on the first trading day of the year, conditions beneath the surface were deteriorating. As a result, any rally attempts in March and May did little to disrupt that change.
As stocks carved out a low in mid-June and finished the first half deeply in the red — but off the lows — there was some hope that a more sustainable bounce would be forthcoming.
To help provide perspective and reduce the feeling that change is suddenly upon us, we put together a “Bull Market Re-Birth” checklist.
The idea was to look beyond surface-level price action and focus on evidence that a durable shift may be occurring. When we discussed the checklist in this space last month , we had just seen multiple days of better than 9-to-1 upside vs downside volume on the New York Stock Exchange. This was the first criteria on our checklist to turn positive. But as we said at the time: “There was still more work to be done.”
The days and weeks that followed have brought new information and have satisfied more of the criteria on our checklist. At the end of July, the percentage of S&P 500 stocks closing at new 20-day highs surged above 55%. This fired the first breadth thrust signal in our work since June 2020.
We don’t look at breadth thrusts as single events, but as identifying favorable risk-and-return environments — we call them breadth thrust regimes — that last for a year. Not only is the presence of a breadth thrust regime typically bullish, but the absence of one can be a challenge for the market.
The S&P 500 lost 3% during the period between the expiration of the last breadth thrust regime (June 2021) and last month’s breadth thrust signal. The Russell 2000 and Value Line Geometric Index were each down more than 15% in that period.
Improvement in August
As the calendar turned to August, we saw more evidence of improvement. We began to see more stocks making new 52-week highs than 52-week lows. At first, it was once or twice on a daily basis. Now, it has been sufficient to turn the trend in our net new high A/D (advance/decline) line positive for the first time since November.
August now has had as many days with more new highs than lows compared with the first seven months of the year combined — and the month isn’t over.
Sometimes even when you are looking for it, change happens slowly, and then all at once.
We are also seeing the shift in the weekly data. After 37 consecutive weeks of more new lows than new highs, last week was the first week in 2022 in which the new-high list was longer than the new-low list. It took until August.
This brings our checklist to four out of five criteria met. The lone holdout is our cross asset risk indicator. The short-term and intermediate-term versions have moved into “risk on” territory, but the version in our checklist has a longer-term focus. While “risk on” assets are well off their lows relative to their “risk off” counterparts, more improvement is needed to clearly signal “risk on” leadership.
Our approach has never been to try and call tops or catch bottoms. I’m more interested in leaning into the trends that are supported by the weight of the evidence. The last two years have taught many of us not to totally write off something as impossible just because it has never happened before.
Markets rarely move in straight lines, but when considering the data we have in hand, the rally off the June lows looks like it has what it takes to stick around for a while.
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.