We had another nice day in the stock market yesterday as the tech sector continued to lead the way higher. It does not seem to matter that the rally is a very narrow one, but history tells us that it never matters...until it does. We got more evidence of this “narrowness” yesterday...as the Nasdaq rallied almost 1.5%, but the breadth for that index was only 2.6 to 1 positive. When the market rallies well over 1%, you’d want to see that breadth above 5 to 1 positive to signal that the rally is a broad-based/healthy one. (We’d also note that the 0.72% advance on the S&P 500 came on breadth that was barely positive at all...at just 1.3 to 1.)
On top of this poor breadth, the volume was very low. That said, we readily admit that it is quite normal to see low volume on a Monday in August, so we don’t want to make too much of this development from yesterday. However, we DO want to point out that volume fell off of a cliff in the month of July. In fact, the composite volume fell by over 41% from the average of the previous five months!!! Yes, we do usually see a very mild drop in volume from June to July...as we move into the summer months...but that’s because June is one of the highest volume months of the year (every year). Besides, even though volume tends to fall slightly in July, it is usually still in-line with the average volume from the previous 4-5 months, so to see it fall so sharply from its five month average was astonishing. Therefore, the severe decline in volume this time around is an outlier....and it reinforces the idea that investors are only interested in a small number of stocks right now.
This does not mean that the stock market will definitely roll-over immediately, but it does show that the risk/reward equation has shifted dramatically since March...and we believe it has left us ripe for a material pull-back...or even a full-blown correction. As we’ve said several times recently, we believe that kind of pull-back would be quite normal...and more importantly, it would be very healthy. Narrow rallies...especially ones that are as narrow as this one has been recently...are not healthy ones. Therefore, we believe the best thing to happen in the stock market this month would be something that involved shaking things up a bit...and taking some froth out of the markets.
To give you another example of how narrow this rally has been, let’s look at the broad NYSE Composite Index. As the Nasdaq has made new all-time highs...and the S&P 500 has come less than 3% within its February highs...the NYSE Composite Index (NYA) still stands a full 11% below its own February highs. That’s right, the NYA remains in correction territory!!!!!
We’d also point out that NYA fell behind the S&P over several months during the summer of 2018...just before the broad market saw a deep correction in the 4th quarter of that year. The same thing took place a little over a year later...when the NYA fell behind the S&P in a pretty significant way during the last few months of 2019 (and into early this year)...just before the broad market fell out of bed.
Now, it has fallen behind the S&P once again. In other words, each of the past three rallies in the S&P 500 have been some-what narrow...which each successive rally more narrow than the previous one. This does not insure that we’ll see another deep correction (for the third time in a row)...especially with the Fed providing a safety net...but it does show that narrow rallies are not sustainable...even though they can last for many months.
Again, none of this means that we’re going to get anything like the huge decline we saw in the 1st quarter...the Fed should prevent that from taking place. However, it IS further evidence that those who say that there is nothing to worry about a ”narrow rally” are way off base. Therefore, we will continue suggest caution over the near-term...now that we are moving out of earnings season...and towards the months the frequently give us some surprising declines.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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