We've been talking about the exuberant sentiment for days now. Since I think sentiment is important if breadth is weak, I thought we'd take a look at breadth. While I promise there won't be any tests, there will be a lot of number crunching.
Let's start with breadth. It can be measured in several ways. The most traditional way is the advance/decline line, where we take the net of the advancers minus the decliners each day. For the cumulative breadth chart, we simply keep adding each day as you would an index. Rising breadth is good, while falling breadth is bad.
I prefer to look at the cumulative breadth against the S&P. In the past four trading days breadth has been flat, making no progress whatsoever. In that same time, the S&P is up about .75%, or 27 points. That is what you don't want to see.
On the chart below in the red box, you can see the blue line (breadth) has been cranking higher. Notice it made a higher high weeks ago while the S&P (brown line) just sort of sat there. This is a positive.
Now notice in the last week the blue line is stalled out while the S&P has gone higher. It's too soon to say it is a problem, but it is certainly the first sign of a potential one.
Notice the green box on the chart. That was the run into late August. Notice how breadth couldn't keep up on that last run. Sentiment was quite bullish then and breadth had turned sour. That resulted in the September decline.
I like to use the McClellan Summation Index to smooth out the bumps in the breadth of the market. On Monday we entered with this indicator needing a net differential of negative 2,100 advancers minus decliners on the New York Stock Exchange just to halt the rise. I consider that a pretty good cushion. As of now, it needs negative 1,300 to halt the rise, and a bit more to roll over.
In the last two trading days, the S&P has gained 24 points and the underpinnings of the Summation Index have weakened just a tad. To put that negative 1,300 into perspective, Monday's net breadth was negative 1,200 so you can see a mild down day takes that cushion away quickly.
Another measure of breadth is the number of stocks making new highs. Three weeks ago the NYSE had 345 stocks making new highs. Tuesday's new high saw 162 new highs, basically fewer than half of what we had a few weeks ago. New highs should be expanding as the S&P makes a higher high.
For now there are just a few days of breadth taking a back seat, but with sentiment as extreme as it is, I am watching that very closely especially, since the Daily Sentiment Index for Nasdaq is now at 88.