Friday, December 18, 2009

Technical Take: Keep an Eye on New Lows

Technical analysis is one of the main building blocks of our forecasting process, along with fundamental macro analysis and valuation. It involves the study of many different market-based indicators, including momentum, sentiment, breadth, volume, divergences, etc. We believe that different market environments require different levels of emphasis on each part of our process, and I think it’s fair to say that today’s liquidity-driven market requires that we devote more attention than normal to the technical condition of the financial markets.

During the current stock market rally, one of the strongest technical measures has been market breadth, which gauges the number of advancing versus declining stocks. Typically, in a healthy bull market advancing stocks significantly outnumber declining stocks, and in bear markets the reverse occurs. One market breadth measure that we’ll be keeping a particularly close eye on is the number of new 52 week lows in the marketplace. The indicator is fairly straightforward – as the name implies, it’s simply the sum of the number of individual stocks that have fallen to a new 52-week low.

Below is a chart that plots the Bloomberg New 52 Week Lows on U.S. Exchanges Index (blue line) against the S&P 500 Index (red line). It shows that as the market began to rebound in March, new lows fell dramatically and have stayed very subdued ever since. Lately, however, new lows have been slowly rising, and even closed above some key moving averages. At the moment it’s too early to tell if new lows are in the early stages of an important trend change, or if this is another false breakout like we’ve already seen several times this year. Either way, we’ll be watching new lows closely for signs that the current bull market is running out of steam.