Market Pulse: Garbage in, garbage out
November 13, 2013
Last Friday was interesting. On that day both equities and interest rates spiked. Stocks were especially strong with the Dow rising 167 points and the S&P 500 rising toward its all-time high.
Yet, throughout the day I heard various analysts warning about the day's "poor market breadth." They were implying that the averages were overstating the advance and that few stocks were participating in the rally.
With the broad-based Russell 2000 index up 1.9 percent these analysts were clearly wrong. Why?
To measure market participation, or market breadth, most analysts look at the number of stocks advancing on the NYSE versus the number of declining stocks.
Here's the problem: Close to half of the securities traded on the NYSE are closed-end bond funds that are tied to interest rates, ADRs, and warrents.
With Friday's interest rate spike, the bond funds moved lower. So upon first glance it looked like many stocks were declining.
While the advancing and declining figures were technically correct, they were misleading because about half of the issues represent "irregular" securities. This can be very misleading. Again, let's look at last Friday:
Financial publications, which use the issues traded on the NYSE, reported that 1781 issues advanced while 1323 declined, which is a ratio of 1.35 to 1 to the upside. Nothing impressive there.
A more accurate measurement of market breadth, however, runs the calculation on a large list of stocks that excludes bond funds.
For my analysis, I crunch the numbers on the 1500 stocks in the S&P 1500 index. Using this method 1263 stocks advanced versus 220 decliners, which is a ratio of 5.7 to 1 on the upside.
The commonly used NYSE data had slightly more advancing issues over declining issues while a stocks-only list had nearly six times as many advancing issues as decliners. That's a big difference.
Having stocks advance on a day when interest rates spike is unusual, but this isn't a typical market. As interest rates trend higher we'll hear even more analysts warning about the market's poor breadth.
It's not that these analyst's calculations are wrong, it's that the data they use in their calculation is flawed. It's a case of garbage in, garbage out.
David Vomund is an Incline Village-based fee-only Registered Investment Adviser. Information is found at http://www.ETFportfolios.net or by calling 775-832-8555. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.