What is Keeping the Stock Market Afloat?
August 10 2018 - Is More Than Big Tech Keeping the Market Afloat? By Dr. Van Tharp Trading Education Institute
I’ve just returned from an amazing trip to Scotland where I was accompanied by my lovely and talented wife and two great friends.
While we were there, we were fortunate to stay in a lovely little town that held the regional Highland Games. These games, which date back over 1,000 years, include bagpipe and drum corps competitions (majestic) and multiple dancing events (graceful). And yes, there are footraces and long jumps where men and woman run and jump to the screaming encouragement of the local spectators.
The greatest allure of the games, however, lies in the strength events where huge men in kilts throw heavy stones, hammers, and even massive logs. The Aberlour Strathspey Highland Games had a “ringer” this year — a man from outside the region who easily won the shot put, hammer throw and heavy weight throw for both distance and height. This mammoth man was at least 75 pounds heavier than any of the other competitors and he was twice as thick.
Because of this, we easily and logically assumed that he would also win the most famous of Highland Game events — the caber toss. The caber is a 19 foot, 6 inch tall log that weighs 175 pounds. Contestants start by balancing the caber vertically in their clasped hands with the narrower end down and then they start running. They finish by tossing the log end over end hoping to get the smaller end to flip over the thicker end and land in a 12 o’clock position in front of them.
This he-man of a human being was first up. He easily balanced the caber but as he started running, he lumbered and laboriously made his toss. While he easily “turned the caber” (getting the smaller end to rotate over the top of the larger end in the air), his log landed at about a 10 o’clock position which cost him points.
The next contestant was younger and leaner. He had more trouble holding the monstrous log but as he started his run, you could see he was so much lighter on his feet — almost elegant — and had more control over his caber. He made his toss and landed a nearly perfect 12 o’clock position.
The logical choice, the one who looked best “on paper,” didn’t end up being the one that performed best in reality. So it is sometimes when you watch men toss telephone poles in a Scottish field . . . as it is sometimes in other endeavors as well.
Advance-Decline Line Versions
Two weeks ago I debunked the myth that only the tech mega caps have been driving the market upward. I used one of my favorite market health indicators — the cumulative advance-decline (A-D) line. Interesting enough, a couple of research firms out there are jousting about the usefulness of various versions of this very same indicator. So as not to take sides, I won’t mention any by name.
Here’s the controversy: there is an ongoing dialog (just how long it’s been going on, I’ll reveal below) where some advocate that the most commonly used A-D line (NYSE) — is not a valid indicator of market health nor is it an early warning tool as a divergence meter. These proponents claim the NYSE A-D line is unsound for these uses because many non-operating entity issues (symbols) contaminate it. According to this reasoning, it has so many interest rate sensitive components that the traditional NYSE A-D line gives a very blurred picture of “stock” market breadth.
To be honest, that’s a very compelling argument on its face. It makes sense . . . just like believing a bigger, stronger guy should be able to throw logs better than a smaller guy. Let’s dig in and see what we find.
Comparing The A-Ds
As of about three weeks ago, here’s the breakdown of the listed issue categories on the NYSE:
Here’s a little more detail about each category.
Common = traditional operating companies like GE.
Bond CEF = Closed End Funds (CEF) that are based on fixed income instruments.
Other CEF = Many of these CEFs are Real Estate Investment Trusts and are also interest rate sensitive.
Preferred stocks = These stocks are mostly issued by “common” stock companies and have hybrid characteristics of both an operating company and a fixed income investment due to their typically high dividends.
Specialty = This category is a catch-all for the unusual listings like rights, warrants, structured products, “when issued”, and anything else that does not fit into the other categories.
Why dig into the arcane makeup of the NY stock exchange? So we can see that two-thirds of the market’s symbols represent operating companies (consider that at least some of the preferred stocks act like their underlying stocks).
For a fully informed view, let’s look first at the A-D line for all symbols and then at the A-D line for operating companies only. Here’s the traditional “all-issues” version:
Just a quick note — in the two weeks since I wrote the previous article on this topic, the S&P 500 has had tiny pullbacks on tariff troubles or concerns over Facebook’s earnings report, but has resumed its upward climb showing that broad market participation continues.
Now, let’s look at the A-D line for operating companies only. Fortunately, the good folks at stockcharts.com have an A-D line for the S&P 500 — operating companies one and all. This chart shows the S&P 500 Advance-Decline line percentage which is a mathematical analog (essentially equivalent) for the straight numbers of the NYSE A-D line. Here is that chart for the same time frame:
Honestly, I can’t see much of a difference. Can you? They look almost identical.
To be fair, you can find some differences in the “all-issues” and “operating-only” lines, but to find the differences, you typically have to look at a far too short of a time frame. That kind of granularity is not useful for such a broad-brush (albeit useful) tool.
The Long Running Debate and Today
How far back does the dialog about the usefulness of the two competing versions go? Quite a long while back. Five years ago, I did a 90 minute webinar centered around this controversy and we saw very similar results. Long before that, however, two of the founding fathers of the stock analysis newsletter business made great calls independently for a market top in the early nineteen sixties. Both cited the NYSE A-D line as one of the tools they used to make their calls. Both were roundly criticized at the time of their calls for using an indicator that was “contaminated” but still, both got the call spectacularly right. I’ll dig more into these two legends and their great call in a future article.
Most importantly, while it’s a blunt instrument, the NYSE A-D has been very useful for almost six decades in warning about market tops. For now, let’s realize that the argument about the problem with the “contaminated” A-D line is fine fodder for academics — and actually makes intuitive sense — just like picking the biggest caber thrower. Here in the real world, the good ‘ol fashioned NYSE A-D just keeps working — and keeps us on the right side of the market.
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