A measure of the market’s internal strength suggests more downside is ahead for stocks

With the S & P 500 now threatening to break below the 5,000 level for the first time since February, investors are struggling to determine whether to consider this a buyable pullback or the beginning of a more sustained decline. One market breadth indicator suggests that we may still be in the early phases of a market decline. We had been focused on the 5050 level for the S & P 500 as a key “line in the sand” for equities. If the SPX remains above that level, then we could easily label this as a garden-variety pullback. But as the S & P has indeed pushed below this support level, with the RSI (relative strength index) pushing below the important 40 level, the recent top appears very similar to July-August 2023 with a protracted decline to follow. How can we validate the recent breakdown using market breadth indicators? Breadth analysis allows us to analyze the movements of the index members that comprise our major benchmarks and get a sense of whether a market move is supported by the movements of those individual stocks. The bullish percent index is a breadth indicator based on point & figure charts, showing the percentage of stocks in a particular universe that are currently showing a bullish point & figure structure. Let’s review the bullish percent index for the S & P 500 to relate the movements in the index to the price action of the index members. We’ve highlighted when the bullish percent index has been above 70% or below 30%, because the most important signal is when the indicator comes out of these extreme regions. Looking back over the last two years, you’ll notice the green-shaded areas in October 2022, March 2023, and October 2023 aligned well with major market bottoms. Because point & figure charts are based on price reversals, the bullish percent index pushing back above 30% is meaningful as it represents a growing number of individual stocks reversing off lows and popping higher. As more and more individual stocks return to a bullish phase, this tends to provide enough upside momentum for the major benchmarks. Many stocks are breaking down The red-shaded areas have been very successful at identifying major market tops, with the notable exception of the January 2024 signal. Due to the dominance of the Magnificent 7 names earlier this year, the S & P 500 was able to push higher despite the weakness “underneath the hood” as represented by the bullish percent index. But generally speaking, a move back below 70% shows that many individual stocks are breaking down, which tends to weigh on the benchmarks. Earlier this month, the S & P 500 bullish percent index again broke below the 70% level, indicating a major market top had likely occurred. With the indicator now pushing below the 50% level, it appears likely that a broader move lower for the S & P 500 could push the indicator down to below 30%. While the market has bottomed out with a reading above 30%, it’s more common to see a drop below this threshold before a major low can occur. With the strength of the S & P 500 and Nasdaq 100 off the October 2023 market low, it can be tempting to treat all pullbacks as buying opportunities. Investors looking for an actionable buy signal may benefit from patience as this market decline continues to play out. -David Keller, CMT marketmisbehavior.com DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.