Hussman - The Ponzi Economy

Weekly Market Comment
John P. Hussman, Ph.D.
September 22, 2014

Market internals continue to deteriorate

An important note on the equity markets: we’re observing a continued deterioration in market internals at extremely elevated valuations, much as we observed in July 2007 (see Market Internals Go Negative). Credit spreads have widened in recent weeks, breadth has deteriorated (resulting in weakness among the average stock despite marginal new highs in several major indices), and downside leadership is also increasing. As a small example that illustrates the larger point, despite the marginal new high in the S&P 500 last week, the NYSE showed more declines than advances, and nearly as many new 52-week lows as new 52-week highs. About half of all equities traded on the Nasdaq are already down 20% from their 52-week highs and below their 200-day averages. Small cap stocks have also weakened considerably relative to the S&P 500.

Indeed, though it’s not a signal that factors into our own measures of market internals (and we also wouldn’t put much weight on it in the absence of deterioration in our own measures), it’s interesting that Friday also produced a “Hindenburg” signal as a result of that lack of internal uniformity: both new highs and new lows exceeded 2.5% of issues traded, the S&P 500 was above its 10-week average, and breadth as measured by advance-decline line is deteriorating. One can certainly wait for greater internal divergence before raising concerns, but my impression is that this confirmation is likely to emerge in the form of a steep, abrupt initial decline (which we call an “air pocket”). That isn’t a forecast, but an observation based on prior instances of deteriorating uniformity following extended overvalued, overbought, overbullish periods. This time may be different. Needless to say, we aren’t counting on that.

The chart below shows the cumulative NYSE advance-decline line (red) versus the S&P 500. While the divergence is not profound, similar and broader divergences are appearing across a wide range of asset classes and security types, and it’s the uniformity of those divergences – not simply the extent – that contains information that suggests that investor risk preferences are subtly shifting toward risk aversion.