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Fun with analogs and breadth thrusts

Summary:
There was an amusing joke tweet that circulated, which overlaid the 2020 market experience over the 2008 bear market and projected a downside target of 125 for SPY. If anyone saw that, it was a joke and not intended to be serious analysis.  Nevertheless, analogs can be useful in analyzing markets, but with a caveat. As the adage goes, history doesn’t repeat itself, but rhymes. Traders who use analogs often expect the market to follow every single squiggle of the historical analog, which is unrealistic. Historical analogs can be useful as a template for market action. The 2008 market pattern suggests that after an initial shock, the market rebounds and trades sideways for some time before falling to a final low. As a reminder, I made a bear case in my recent publication (see Why the

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There was an amusing joke tweet that circulated, which overlaid the 2020 market experience over the 2008 bear market and projected a downside target of 125 for SPY. If anyone saw that, it was a joke and not intended to be serious analysis.
 

Fun with analogs and breadth thrusts

Nevertheless, analogs can be useful in analyzing markets, but with a caveat. As the adage goes, history doesn’t repeat itself, but rhymes. Traders who use analogs often expect the market to follow every single squiggle of the historical analog, which is unrealistic.

Historical analogs can be useful as a template for market action. The 2008 market pattern suggests that after an initial shock, the market rebounds and trades sideways for some time before falling to a final low. As a reminder, I made a bear case in my recent publication (see Why the market hasn’t seen its final lows) that stock prices are vulnerable to further downside risk based on a review of long-term market psychology, technical analysis of the cycle, challenging valuations, and the behavior of smart investors.  The downside potential for stock prices is considerably lower than what they are today.
 

Fun with analogs and breadth thrusts

Similarly, the 9/11 exogenous shock is also a useful template for thinking about market behavior. The economy was already in recession in 2001, but the market did not bottom until a year later in 2002. Things are different today, the economy was humming along and poised for a solid but unspectacular 2020 when it was hit by the dual broadsides of the COVID-19 pandemic and an oil price war. Stock prices skidded after the 9/11 attack, recovered to trade sideways until it fell into the final lows in late 2002.
 

Fun with analogs and breadth thrusts

I would also point out that I reviewed past major market bottoms four weeks ago (see 2020 bounce = 1987 or 1929?), I concluded:

After an initial bottom:

  • The market either forms a W-shaped choppy bottom, or a bounce and retest
  • The retest may not necessarily be successful. Failures of retests have usually occurred when the economy was in recession.

Every market is different, and your mileage will vary. The lessons from these bear markets indicate a period of choppy range-bound price action. No one has a crystal ball that can tell you whether the advance will halt at the 50% retracement level, or if it will continue.
 

Breadth Thrusts, reconsidered

As an update to yesterday’s post (see A Dash for Trash countertrend rally), one reader pointed out that my analysis of the Whaley Breadth Thrust (WBT) had referred to the wrong table from Wayne Whaley’s publication. The history of WBTs was on table 2, not table 5.
 

Fun with analogs and breadth thrusts

Here is a revised analysis of the key differences between the WBT and my preferred signal, the Zweig Breadth Thrust (ZBT) in 2009. There were three WBT signals and one ZBT signal during this period. As the ZBT Indicator (bottom panel) shows, WBT signals only require strong momentum that moves the ZBT Indicator into overbought territory, while the ZBT signal requires the combination of an oversold condition and strong momentum in a short period. During this period, the first WBT signal failed, the second WBT coincided with the ZBT signal, and the third, while successful, was not as strong as the ZBT signal.
 

Fun with analogs and breadth thrusts

Here is the ZBT Indicator today, which has moved into overbought territory but not within the 10 day window required for a buy signal. By contrast, the WBT model is on the verge of a buy signal.
 

Fun with analogs and breadth thrusts

Of the three WBT during 2009, one coincided with the ZBT signal and worked well. Of the other two, one failed, and one worked, though subsequent momentum was not extremely strong. We can conclude that the WBT model is less rigorous than the ZBT model, and therefore more prone to failure and more false positives.

As well, Mark Ungewitter compiled the track record of WBT buy signals since 2002. If we we exclude the WBT signals that coincided with ZBT buy signals, the track record is mixed, with a win rate of 50%.
 

Fun with analogs and breadth thrusts

Brett Steenberger also offered a slightly different perspective on the current strong momentum in a Forbes article:

According to data from the Index Indicators site, over 90% of stocks in the Standard and Poor’s 500 Index closed above their 5, 10, and 20-day moving averages this past Thursday! Moreover, if we look at the shares in the Standard and Poor’s 600 index of small caps, we see the exact same pattern. And the Standard and Poor’s 400 index of mid cap stocks? The same thing: over 90% trading above their 5, 10, and 20-day moving averages. In other words, over the past two weeks, it’s not just that the indexes were higher: almost every single stock in every single market was bought! In a very real sense, the buying has been as broad and extreme as the prior selling.

Steemberger identified 10 occasions of strong buying, namely January 2, 2009; March 23rd and 26th, 2009; March 5, 2010; September 13, 2010; July 1, 2011; August 31, 2011; October 24th and 27th, 2011; October 31, 2014; March 11, 2016; and January 18, 2019. He went on to analyze three past episodes because “they were the dates of broad market rallies where the overall market volatility was similar to today’s market (VIX > 30)”. These were: January 9, 2009, which roughly coincided with the first WBT that failed in our 2009 study; March 23 and 26, 2009, which occurred at about the same time as both the very successful WBT and ZBT; and August 31, 2011, which is shown in the chart below. The 2011 period also saw a ZBT buy signal in October 2011, whose subsequent returns were positive but weaker than usual, and a false breadth thrust observed by Steenberger in late August when the ZBT Indicator went overbought but the market failed to follow through.
 

Fun with analogs and breadth thrusts

Steenberger went on to tentatively conclude that these signals tend to be better long-term investment buy signals than trading signals.

My main takeaway is, if you are going to trade on breadth thrusts, trust the real thing and only buy ZBT signals. The ZBT model has a more restrictive criteria which raises their short-term success rate. By contrast, other strong momentum breadth signals tend to be more hit and miss affairs, even in the current environment where the VIX Index is highly elevated.

About Cam Hui
Cam Hui
Cam Hui has been professionally involved in the financial markets since 1985 in a variety of roles, both as an equity portfolio manager and as a sell-side analyst. He graduated with a degree in Computer Science from the University of British Columbia in 1980 and obtained his CFA Charter in 1989. He is left & right brained modeler of quantitative investment systems. Blogs at Humble Student of the Markets.

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