ETF Expert

One may not need much more than the CBOE Volatility Index (VIX) and the S&P 500 SPDR Trust (SPY) to forecast near-term weakness in U.S. stocks. The current price on the VIX has been flirting with a closing value above its 50-day moving average, while the price on SPY has already slipped beneath a long-term 200-day trendline.

Fundamental analysts might take issue with downbeat directional forecasts, of course. The S&P 500 figures to be trading at a forward P/E of just 12, and the robustness of the corporate bond market normally portends positive things for equities.

Yet when will investors shake the short-term apprehension? We can’t look to fundamental analysis for that answer. It was dreadfully wrong as the credit crisis deepened in ‘08 and a full-fledged panic embraced the “black swan.” Risk managers need to consider technical indicators to see whether fear may indeed turn to panic.

The folks at ETF Investment Outlook serve up a popular tool known as “price breadth.” In brief, here is where one can check the raw numbers and percentages of stocks in an ETF that are advancing or declining.

For instance, the SPDR S&P 500 Trust (SPY) may charge forward 1.0% on a low-volume trading session. However, that wouldn’t tell you whether there were more advancers or decliners in SPY. There may have been 260 advancers with 240 decliners, which would suggest that the positive breadth was mild at best.

Keep in mind, a single day is not indicative of a trend for advancing and declining stocks. That’s why the more meaningful data for determining the likelihood of direction comes from assessing price breadth over a particular time frame.

At the moment, I’ve chosen to focus on near-term price breadth. For example, I wanted to look at moving averages of advancers versus decliners in the 10 primary Sector ETFs over the prior 3 months (60 trading days). An Advance/Decline Net % that is higher than the 60-trading day trendline could predict desirable results in the weeks ahead, whereas an A/D Net % that is below its 60-Day Moving Average might spell some trouble on the horizon.

Houston, we don’t exactly have “lift-off.” 80% of the economic segments show negative A/D Net% over the prior 3 months. Worse yet, the weakness of the consumer is particularly evident in financial stocks and discretionary stocks; both were at the heart of the 2008 bear’s start.

I’m not suggesting that a bear for U.S. stocks is imminent, or even probable. In fact, when we look at AD Net% over longer periods, stocks still have attractive breadth results. Over 6 months, the situation is reversed; 80% of economic sectors — everything but health care and energy — demonstrated positive price breadth. And the AD Net % readings for all 10 sectors were positive over 9 months (250 trading days).

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