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Internal Combustion: Anatomy Of A Market Top-Part 1

September 5, 2015

Internal Combustion: Anatomy Of A Market Top-Part 1

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Over the past few months, we have detailed the systematic deterioration in the internals of the stock market. This trend recently reached depths historically seen only near major market tops.

This is Part 1 of a 1 or 2-Part series on factors that are characteristic of a cyclical top in the stock market. It should really be a 3-Part series but, like Star Wars, we skipped over the 1st part of the story. Part 1A would have covered what we term the “background” conditions of the market. These background conditions – including valuation, sentiment, stock allocation, long-term price vs. trend, etc. – convey the general market environment that exists. These conditions are not catalysts or actionable indicators. Rather they reflect the market’s backdrop, instructing us as to which cyclical trends are likely to develop, at some point. Now, the status of these background conditions can persist – and for a long time. Indeed, we have been discussing the overbought/extended/high-risk nature of various of these indicators for years already. So, in a way we have covered the true Part 1 of this “Market Top” series, just not in a formal sense (our October 2013 Newsletter may have been the closest to an actual “Part 1”).

This piece covers the “internals” of the stock market. Internals (or breadth) refer to the level of participation among stocks throughout the entire equity market. It includes metrics like the number of stocks that are advancing versus declining, the amount of volume in advancing stocks versus declining stocks, the number of stocks that are making new 52-week highs versus new lows, etc. In our view, strong internals, i.e., widespread participation among stocks, is an important ingredient of a healthy market.

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