Keep an Eye on Market Leadership!
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Lots of investors track market leadership when measuring the risk of participating in the stock market. A down trend in market leadership precedes practically every bear market so it’s wise to take changes in leadership under advisement. For those who are not familiar with the concept of leadership, it’s basically a measurement of stocks hitting new highs versus stocks hitting new lows. Market technicians create all sorts of fancy calculations that in some way calculate the ratio of stocks hitting new highs versus new lows. (It’s important to point out that nearly all analysts use 52-week high and low figures because they are the most readily available and most commonly accepted.)
I follow several analysts who calculate leadership in various ways. When the market pulled back in May – June of this year, market leadership dried up and by some calculations it actually turned mildly bearish. Since then, leadership has gradually improved and currently it stands somewhere between neutral and mildly bullish. The fact that leadership is only mildly bullish when stock indexes are hitting new highs is disturbing in and of itself.
Furthermore, I believe that something is about to take place over the next several weeks that will likely reverse the bullish trend in leadership. So here’s the rub. I think leadership will start to deteriorate because a significant number of stocks with start hitting 52 – week lows not because of what is about to happen in the market but what happened in the market 52 weeks ago…
From 10/27/05 thru 12/1/05, the Wilshire 5000 index moved up nearly 8% - a 400% annualized return! With the exception of the mild correction this summer, the market has undergone a fairly consistent move up since last fall. The majority of stocks that hit 52 week lows in June were Energy and Resource stocks, therefore, the 52 week low price for rest of the market was established last fall following Katrina. (The exception is the homebuilding sector which has been hitting new lows for the last several months.)
As we move forward in the year, existing 52 week low prices will be taken out and replaced by higher lows because of the market’s significant move 52 weeks ago. Therefore, unless the stock market makes a similar and highly unlikely move in the waning months of the year, many stocks will see their 52 week low price come up to meet its current price and the cumulative effect of this will lead to weaker leadership in market – a necessary precursor to a bear market.
