Peking Goose!

Peking Goose!  Markets were goosed by a Chinese government tax cut and pledge for more stimulus to help the country through its current soft patch.  In a somewhat tumultuous news day stocks traded in the black for the entire session pulling back several times only to close on or near session highs.  Netflix did its share to spur on the FAANGs as it announced plans to increase prices which was met with buying fervor.  This goes to show that when investor sentiment is good there is not much that will get in the way of buyers.  In most cases on Wall Street, almost any bit of news can have multiple interpretations.  In the case of Netflix announcing price hikes, anyone who has studied micro economics (or reads my market note) knows that when a company raises prices, demand for a product will generally decrease.  So a price hike by Netflix should have a negative effect on earnings as demand for the product will go down, right?  Wrong, investors cheered the move hoping for higher revenues resulting from potentially higher margins.  In this case investors chose the positive interpretation. Similarly, in late December the Fed officials led by Jay Powell went on a “stabilize the market” media campaign with the message that the economy is showing signs of weakness with possible global headwinds so the pace of rate hikes will be approached with patience.  Interpretation 1: Domestic economy is showing some signs of slowing down, emerging markets are slowing down (China), and developed markets are slowing down (EU) which can only be negative for stocks.  Interpretation 2:  Fed will stop raising rates and might even consider lowering them which can be positive for stocks, especially those that are interest rate sensitive.  It should be clear by now that the markets have chosen interpretation 2 as stocks have posted a broad based rally since Powell kicked off the campaign in the final days of 2018.  Investor sentiment is a big factor in market movement as can be evidenced by the stock market’s behavior in the 4th quarter of 2018 when stocks were pummeled despite continued record earnings growth, strong economic numbers, tame inflation, and an unemployment rate hovering at record lows.  By December, many investors simply gave up but it appears that now sentiment is changing.  A good way to gauge investor sentiment is through market breadth, which is characterized by the Advance / Decline line.  Because it is geek-out Wednesday, I think today would be a good day to introduce the AD line.

The Advance / Decline Line (AD Line) is a technical indicator which tracks the breadth of market moves over time.  The term market breadth refers to the level of participation in a stock index’s move.  First of all why would we care about that?  If an index goes up, well, it’s going up and that should be good enough right?  Not really. Most equity indices are cap-weighted, that is to say that larger market cap companies have a larger impact on the way an index is calculated (from more information on Indexes please refer to my market note on the subject here: https://www.siebertnet.com/blog/index.php/2018/08/29/rolling-with-it/ ).  For example on the S&P 500 index, which contains the top 500 capitalized stocks (listed on the NYSE and NASDAQ), the top 3 components are Microsoft, Apple, and Amazon and their combined weights represent almost 10% (9.84% specifically) of the index.  Extending it to the top 5 (to make the math easy), which includes Berkshire Hathaway Class B and Facebook, we get to a combined weight of 13.21%.  So 1% of the companies on the S&P500 have an impact of 13.21% which means that movement of a few stocks can affect the performance of an entire index.  Because of this, tracking an index’s movement alone tells us very little about what is happening in the broader market.  The S&P500, the Russell 2000, and the NASDAQ 100 are all cap weighted indexes which can suffer from the same distortion.  The Dow Jones Industrial Average is a price weighted index which also suffers from a similar anomaly as its top 3 weighted stocks (Boeing, United Health Group, and 3M) represent 22.5% of the index.  By now you can probably see that it would be beneficial to get a better understanding of the breadth of market moves.  The simplest way to accomplish this is by looking at the AD Line.  The AD Line is calculated as follows:

Advance Decline Line = ( At – Dt ) + ADy

Where:

At = number of stocks that advanced today

Dt = number of stocks that declined today

ADy = Advance decline line from prior period

For example:

Using numbers from yesterday’s close.

At = 379

Dt = 256

ADy = 61966

Advance Decline Line for 1/15 = (379 – 256) + 61966

= 62089

Interpreting the AD line is relatively simple.  In the example above, we can note that yesterday’s move had a fairly broad participation in which there were 123 more advancing stocks than declining ones (379 – 256).  While that is interesting to know, the actual number of the AD Line is actually meaningless on its own and the indicator only becomes useful if viewed in a chart.  I have attached a chart of the AD Line over the past 6 months which shows the AD Line in white along with the S&P500 in orange bars.  The white dashed line is the trend of the AD line and the orange dashed line is the trend of the S&P 500 since the late December lows.  You will notice that, over this time period, both the AD Line and the S&P 500 went up.  In fact the AD line advanced even more rapidly.  When both the AD Line and the underlying index go up together, technicians call that a confirmation, we know that a rally is broad-based and that is a bullish signal.  If the AD Line were going down while the underlying index was advancing, technicians would call that a divergence, we know that a rally is not broadly based and that is a bearish signal.  So what does this mean for the recent move in the S&P 500?  The rapid decline in the AD Line starting at the beginning of December through Dec. 24 was quite extreme indicating a broad selloff (in fact it was one of the largest downward moves in the past 7 years or so). The turn around and recovery that occurred after the low indicates broad participation which is a healthy sign for the market.  If the AD Line would not have recovered so rapidly as was not the case, traders would wonder if the narrow breadth of the recent rally could be sustained.  So the fact that this last turn around is broad based is another indicator that investor sentiment may be improving.

Today we will not be getting the Retail Sales numbers due to the Government shutdown (yeah that is still a thing) but we will get the Federal Reserves Beige Book which contains anecdotal information on economic conditions across all of the Fed regions.  The release can include interesting information regarding changes in trends but generally does not move markets unless there are extremes.  We will also get the NAHB Housing Market index which is expected to come in at 56 flat from last month. The index has been trending down but a reading above 50 is still positive indicating that more builders view conditions as good than poor.  More bank earnings are poring in this morning and so far at the time of this writing all have beaten estimates except for Black Rock and PNC, which missed by -3.6% and -3.9% respectively.  British prime minister Theresa May will face a no confidence vote in the wake of yesterday’s voting down of a Brexit deal, though she is expected to survive the vote.  Brexit, shutdown, and more Fed sweet talk will continue to dominate the dialogue today though earnings should take top billing as the broad-based central bank rally looks to continue.  Please call if you have any questions.

daily chartbook 2019-01-16

SP500 AD Line 6 Mos