Market Breadth Could Be a Liability as Stocks Struggle to Maintain Highs

Equity futures are slightly higher ahead of the open despite yesterday’s selloff into the close. Investors are sifting through another swarm of earnings, but the big headliners will come after the close today when Apple AAPL and Amazon AMZN report.

Investors will be looking to see if Apple can deliver phones for Christmas in light of the chip shortage. And, Amazon’s cloud business could be in focus as the “work from home” cloud business was good for Alphabet GOOGL but disappointing for IBM IBM.

The Dow Jones Industrial Average ($DJI) is pointing higher ahead of the open with components Merck and Caterpillar announcing positive earnings. Drug company Merck MRK reported better-than-expected revenue and earnings prompting it to rally 1.85% before the opening bell. The company also raised its full-year outlook for earnings as the success of its new cancer drug continues to help the company grow.

Caterpillar CAT is also higher in premarket trading after beating earnings estimates despite missing revenue. The company appears to be able to navigate higher costs because of the higher number of orders. However, the company is cautious and stressed that there could be trouble in meeting the orders. Despite the caution, Cat Financial reported 110% increase in the division’s earnings because lending remains solid.

Comcast CMCSA beat earnings as well thanks to growth in broadband and recovery in its Universal Studios theme parks. The stock was up 3.6% in premarket trading.

On the negative side, e-commerce firm Shopify SHOP is down 3.6% before the open in response to missing on earnings and revenue. The company reported issues with the global supply chain, but also lower e-commerce growth. This could be a sign that consumers are changing their focus from online shopping to other avenues.

Also, Royal Dutch Shell (RDS/A) is down 4% in premarket trading after the oil company missed on earnings. The company cited costs related to damages from Hurricane Ida in the U.S. as a reason for the miss. The company is also setting tougher emissions targets for itself which could add to its growing costs.

Crude oil (/CL) is falling a little as Iran rejoins the nuclear talks. Lower prices could provide some relief for transports, particularly airlines where fuel is such a large expense.

The Other Day

After a choppy day of trading on Wednesday, stocks sold off into the close. It was supposed be a big week for big tech, but so far, it’s been a mixed bag. While eBay EBAY isn’t as big as some of the other tech firms, it still has some pull. However, the stock was down more than 4% after the bell despite better-than-expected revenue and earnings. Unfortunately, the lower forward earnings guidance failed to impress bidders.

After the close, Ford F announced earnings that looked somewhat similar to General Motors GM that were released in the morning that was better-than-expect but lower-than-expected revenue. GM fell 5.42% on the day, but oddly, Ford was up more than 9% in before the open. The difference appears to be that Ford increased its 2021 earnings guidance and reinstated its dividend.

Overall, carmakers have had a decent year despite the shortage in vehicles. The shortage has also helped in selling car parts as more people choose to fix what they have. O’Reilly Automotive ORLY announced after Wednesday’s close and beat on top- and bottom-line estimates. Despite the positive news, investors didn’t appear to be too excited about what’s under the hood because the stock was only slightly higher in after-hours trading.

Out of Breadth

The S&P 500 (SPX) is trying to follow through on its new highs, but there appears to be a lack of breadth behind to push it along. Breadth refers to the number of stocks that rise and fall at the same time. A broad market rally is one where the majority of stocks rise. Conversely, a broad market sell-off is one where the majority of stocks fall. There are several ways to measure market breadth—one popular way is the A/D line.

The A/D, or advance/decline, line indicator measures the number of stocks trading on the New York Stock Exchange that are rising or advancing against the number of stocks that are falling or declining on a given day. If the A/D line is going up, then the majority of stocks are advancing. If it’s going down, then the majority of stocks are declining.

Many investors look for divergences in the S&P 500 and the A/D line to help determine the strength of a bull or bear market. The graph below shows that the A/D line has moved sideways since June, which suggest that there is hesitancy and uncertainty in the overall stock market. When the A/D line goes sideways or down as the S&P 500 goes up, this is a divergence. The lack of market breadth can weigh down the performance of the stock market.

On the bright side, the A/D line was able to eke out a new high with the S&P 500, but it’s also currently pulling back with the index too.

CHART OF THE DAY: BAD BREADTH. The S&P 500 (SPX—candlesticks) has created new highs but is struggling to gain momentum. The A/D Line (green) has moved sideways since June, and the Russell 2000 (RUT—pink) has moved sideways since March. Data source: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Soldiers & Generals: Another way that investors measure breadth is by comparing stocks of different sizes. The S&P 500 is made up of large- and mega-cap stocks. These are the biggest companies in the United States and in some cases the world. The Russell 2000 (RUT) is a small-cap index, which means it tracks 2,000 of the smallest publicly traded companies. If both indices are moving up, there’s wide breadth in the market.

Some investors refer to the S&P 500 as the generals and the Russell 2000 as the soldiers. If the soldiers aren’t following the generals, then the stock market will likely keep advancing. However, the Russell 2000 has oscillated sideways since March, while the S&P 500 has moved mostly up. Investors who follow this strategy would say that in order for the bull market to continue, many of the soldiers need to start falling in line.

Highs & Lows: Breadth can also be measured by the number of stocks that are creating new highs and new lows. Stocks that are creating new highs are bullish. Therefore, stocks creating lows are bearish. NYSE New Highs 6M ($NYHI6M) tracks the number of stocks that are creating new six-month highs, and the NYSE New Lows 6M ($NYLO6M) tracks the number of stocks that are creating new six-month lows.

Through most of the year, new highs have outnumbered new lows by a large margin. However, in July, the number of stocks that were creating new highs decreased dramatically, while the number of stocks creating new lows has been increasing. This seems to reflect what we’ve seen with the Russell 2000 and the A/D line—market breadth has weakened.

Pushing the Panic Button: So, is it time to push the panic button? Not necessarily. In my recent November Outlook article and several times here in the Market Update, I’ve pointed out that the market and the economy are dealing with a lot of issues right now, including the possibility of Fed tapering, inflation, supply chain issues, and worker shortages. That’s a lot to digest. And, while there may not be broad buying, but there’s also not broad selling. Therefore, it appears many investors are in a wait-and-see mode. There’s nothing wrong with that mode as along as investors can be patient.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

Image Sourced from Pixabay