Chart of the Week: New 52-Week Highs

There has been a good deal of debate in the investment community lately about whether equities are currently overbought. As a look at charts of individual equities I am struck by the number of stocks that are now making fresh 52-week highs.

This week’s chart of the week below chronicles one year of 52-week highs in the NYSE. Using new highs as an indicator of internal market strength, it is easy to see how momentum has continued to build over the course of the last year, with so many stocks hitting new highs last Friday (614 on the NYSE) that breakouts to new highs have created their own self-sustaining demand.

It only takes a couple of negative days to turn the new high trend in the other direction, but I have always been reluctant to short stocks that are making new highs. Even at historically elevated levels, an increasing number of new highs is a sign of strong market breadth and a healthy, broadly diversified rally.

For more on related subjects, readers are encouraged to check out:

• New Highs and New Lows for Market Timing
• The 52 Week Lookback Period and New Highs – New Lows
• Mamis Overbought Oversold Indicator
• Relative Highs and Lows in the SPX
• Canary or Canard?
  

[source: StockCharts.com]

Edit: Steve Place had an excellent suggestion that I try an arithmetically scaled (proportionally spaced) chart for these data sets. I have added a second chart with that arithmetically scaled Y-axis here.

Disclosure(s): none

New Highs and New Lows for Market Timing

The McClellan Summation Index, the subject of yesterday’s market sentiment post, examines the difference between advancing and declining issues to help divine the future direction of the markets.

Today I am going to make the leap from daily advances and declines to daily new highs and lows covering a trailing 52 week period.

Before I dive in, I want to highlight the consistently excellent work of Headline Charts, a blog that regularly addresses issues such as advances and declines, new highs and new lows, as well as other market sentiment metrics. Today is no exception, as Headline Charts examines the ratio of new highs to new lows as well as the rarely seen inverse ratio, new lows to new highs.

I have also recently had the benefit of reading the encyclopedic and aptly titled market breadth tome, The Complete Guide to Market Breadth Indicators: How to Analyze and Evaluate Market Direction and Strength by Gregory L. Morris. This is obviously a labor of love and an indispensable resource for thinking not only about market breadth, but indicators of all types. Think of it more as a reference book than something to curl up with and you can get a better sense of its ideal application.

Spurred on by Morris’ research and analysis, I have been evaluating a number of market breadth indicators and am currently favoring a rather simple one for the intermediate term: new highs minus new lows, with a 4 day EMA smoother. One simple rule is to be long when the EMA is positive and short when it is negative. You can use a longer EMA or a SMA to smooth out the values a little more and cut down on whipsaws, but I like the 4 day EMA and will be adding this indicator to my short list of favorites.

You will note that the new high – new low indicator is currently recommending a long position in the markets, with a considerable cushion before it is likely to reverse.

Did We Dive Deep Enough?

After five weeks of increased volatility and a pullback in the S&P 500 that topped out at 6.7%, the question everyone is asking is whether the 6.7% drop was enough to wring out the excesses of the bull market and provide a wall of worry for further advances…or whether a nastier bear ambush lies just around the corner.

In a Sentiment Primer (Long), I did not spell out which scenario the sentiment indicators are pointing to, but if you read my comments on the ISEE the previous day, you know that the case for a resumption of the bull market is strong.

One group of indicators that I purposely left out of my sentiment primer is variously know as market internals, momentum, strength, etc. These include market breadth (advance-decline lines) data, the number of new highs and lows, and the percentage of a group of stocks trading above certain moving averages, among others. I will talk about these indicators in more detail in a future post, but for today I merely wish to update a chart I first posted and discussed here two weeks ago: a ratio chart of the new highs in the NYSE to the VIX.

The current version of the chart, appended below, shows the full extent of the effect on the ratio during the market pullback, in which a small “W” formed in the SPX. By the standards of the past four years, the drop in the ratio was relatively mild compared to other drops, including the May-July 2006 correction. This is partly due to the dramatic spike in the VIX, as we have discussed here ad nauseum, but also a function of the persistence of new highs in the NYSE, as recently noted by Headline Charts.

For the last three years, the 52 week average (not plotted) for the NYSE new high to VIX ratio has held steady in the 10-14 range. As current readings approach this range, the likelihood of the markets running into another bear ambush and bout of echo volatility is slowly receding.

(click to enlarge)

Canary or Canard?

Earlier in the week, I introduced a ratio chart of the percentage of S&P500 stocks above their 50 day SMA divided by the VIX. I described this as an attempt to find a rough approximation of greed ÷ fear. Since this chart received some favorable reviews, let me unveil another VIX ratio chart that attempts identify the same market sentiment extremes and provide a warning about the increased probability of near-term market highs and lows.

The chart below is a weekly chart of the ratio of the new 52 week highs in the NYSE divided by the VIX. I focus primarily on the raw number and the 4 week SMA. You can see from the chart that raw reading above 30 and a 4 week SMA readings above 20 tend to signal that a top is near.

In fact, this chart provided excellent advance notice of the 2/27/07 top, the 5/11/06 top, and previous tops in March 2004 and March 2005. With bottoms, the record is not quite as good, with an excellent advance call of the October 2005 low, but calls that were too early for May-July 2006, March-August 2004, and July 2002-March 2003.

You can decide if this ratio chart deserves a spot in your toolbox or bird cage or whatever it is that you use to try to divine the future. For me, it’s a keeper.