Hope carefully. Stocks rose yesterday on a series of reports that indicated encouraging results in the race for a COVID cure. EU stocks got a boost from a long awaited, unified, stimulus package while US stocks are reporting positive earnings surprises.
N O T E W O R T H Y
Take a deep breadth. Yeah, I spelled that correctly… it’s breadth, as in the measurement from side to side. To stock market traders, specifically technicians, it means something altogether different. Breadth in stock market indexes tracks the difference between advancing and declining stocks. Generally speaking, when more stocks are going up than down in a stock index, buyer interest is stronger which is viewed as a positive signal for the index. One can calculate breadth in a number of different ways, but the simplest method involves subtracting the number of advancing stocks from declining, this is referred to as the Advance/Decline Line (A/D Line) of an index. So if 300 stocks advanced on the S&P500, the daily breadth would be 100 (300 advances - 200 declines). In contrast, a negative number indicates more selling than buying. An example of that would be if only 100 stocks advanced in a session yielding a breath of -300 (100 advances - 400 declines). There are other more complicated ways to measure breadth which include volume, but the basic calculation does a pretty good job at providing a market snapshot. Now, to be clear, the indicator is not good at providing buy and sell signals, but it is able to show general sentiment toward an index. Positive breadth = positive, bullish sentiment and vice versa. Why did I pick today to explain this very old but still very relevant indicator?
I have been writing a lot about the composition of indexes. Specifically the S&P500 which is perhaps, the most watched benchmark. The index represents the largest market capitalization stocks listed on the US stock exchanges. The index is capitalization weighted which places heavier weights on larger companies. Market capitalization is derived by multiplying the number of outstanding stock shares of a company by its price. When prices go up, so does market cap. Therefore successful companies generally have high market caps, making the index a bit of a winner’s club. If we look at the biggest members of this exclusive club, we find what we might call the usual suspects. The top five are: Microsoft (MSFT), Apple Inc. (AAPL), Amazon.com Inc. (AMZN), Facebook Inc. Class A (FB), and Alphabet Inc. Class A (GOOGL). Surprised? Surely not. Their index weightings are 5.97%, 5.96%, 4.98%, 2.2%, and 1.75% respectively. I will do the math to let you know that those top five stocks represent around 20% of the index. The last time that only five stocks represented 20% was 1979. One can say that the group has a heavy influence on the performance of the index. The post-pandemic market included investors clamoring for technology stocks as they are perceived to be less susceptible to an economic downturn. Interest in those stocks has pushed all of them to all-time highs while the broader markets have languished. Now that the S&P500 is in positive territory for the year (+0.82% as of yesterday’s close), one may wonder, based on the index’s makeup which stocks have done most of the pulling and now you know, if you didn’t already suspect it. Knowing that, one might question how healthy it is for an index to have climbed so much at the hands of just a few stocks. Another way to look at the market’s health is through the market breadth mentioned above. Last week, investors appeared to lose interest in technology shares, surprising many in the “you can’t go wrong buying tech” group. On Monday, interest appeared to have picked up as the fab five experienced a very positive day (Amazon alone was up by +7.93%). Those top five companies helped pull the S&P500 index up by +0.84% on the day. The market breadth on Monday was -147, which means that 147 more stocks declined than rose on a day when the index was up. When more stocks go down than up on a day when the index rises, it is considered unhealthy, flashing warning signals, especially when the index is dominated by one type of stock. Technology stocks have had a good run, and justifiably so with their ability to continue to grow revenues. As index influence works in both ways, many analysts are beginning to wonder what the effects might be if technology shares slip due to their high valuations. Based on the numbers I just shared with you, I presume that you know the answer. High flying Tesla has a market cap of $290.95 billion and is conspicuously not part of the S&P500 due to listing requirements. The company will report earnings today after the bell and if it reports positive GAAP earnings it will be admitted into the exclusive club. While it may not have as much influence as the top five, you can bet that it will certainly have an impact on both the index and the stock.
THE MARKETS
Stocks traded higher yesterday on positive advances in the search for a COVID therapy. Stocks were also propped up by positive sentiment pour-over from the EU’s historic agreement to provide fiscal stimulus at the EU level. The S&P500 rose by +0.17%, the Dow Jones climbed by +0.60%, the Russell 2000 advanced by +1.33%, and the Nasdaq Composite slipped by -0.81%. It was a tough day for tech and you can tell by the decline in the tech-heavy Nasdaq and underperformance of the S&P500 (see above). Bonds rose and 10-year treasury yields gave up -1 basis point to 0.60%.
NXT UP
- FHFA House Price Index (May) is expected to have risen by +0.3% compared to a +0.2% rise in April.
- Existing Home Sales (June) may have jumped by +21.4% for the month, reversing a -9.7% decline in the prior month.
- This morning Thermo Fisher Scientific, KeyCorp, Nasdaq, Northern Trust, and Biogen beat earnings estimates while Baker Hughes missed. After the closing bell we will get results from Chipotle, Whirlpool, CSX, Discover Financial, Tesla, Microsoft, Kinder Morgan, and Las Vegas Sands.