Market Breadth: Does It Really Matter?

Of all the "market internals", breadth is certainly regarded as the most significant. If the market is climbing, it's always healthiest when a growing number of stocks participate in the rally. However, using advancers vs. decliners to monitor the health of the stock market has also been curiously steeped in controversy for years.

The problem boils down to this: NYSE breadth has proven to be very reliable and has always behaved "rationally" , while NASDAQ breadth has been equally unreliable and -- by some metrics -- essentially useless for over a decade.

Serious technicians analyze breadth in "cumulative" mode. This method simply plots a running sum of advancers-less-gainers. Since 1969, Sherman and Tom McClellan have used cumulative A/D to calculate their famous McClellan Oscillator as well as their NASDAQ "summation" index, NASI. In effect, the McClellan's helped popularize cumulative A/D as a technical indicator.

The 15-year chart below shows NYSE breadth (red) in cumulative mode, with SPX price (gray) superimposed. As you can see, the two maintain a very "rational" relationship. A/D began declining in mid-1998 as the SPX went parabolic, a sign that something was amiss. A/D then began climbing as the market corrected, until in 2002 when they not only synchronized, but and breadth accelerated! Breadth has now outpaced both the SPX and Dow higher for over 5 years, a very bullish feature accompanying their all-time highs.






In contrast, nothing could look more different than a similar chart of NASDAQ breadth (FYI -- NASI mirrors this chart very closely). The baffling truth is that except for an 11-month uptick in 2003, NASDAQ breadth has trended negative for 15 years!. Using cumulative breadth as a NASDAQ timing indicator would have kept you out of the stock market essentially in perpetuity.

The problem is that the NASDAQ has gained 375% since 1992 (not even counting the epic 1998-2000 run-up). In fact, using cumulative NASDAQ breadth as a sole timing tool would have produced miserable results for most of the NASDAQ's 36-year history. This is the gist of the criticism leveled at NASI for so many years. How important can a tool be if it produces sub-par results for its entire lifetime? What's going on here?







As luck would have it, about three weeks ago I stumbled across How Cumulative Breadth Can Mislead You by Babak at his excellent blog, Trader's Narrative. In his post, Babak responded to Michael Panzner's assessment that, based on cumulative A/D, the NASDAQ was running out of steam. This is a very common observation, and in April, Bill Luby steered me to Stephen Vita's equally skeptical Breadth/Schmeadth.... TOF even pointed out recently that NASI -- long-regarded by him as the "poor man's timing chart" -- has been "unreliable for the past year or so".

In his response to Panzner, Babak pointed out that a moving average of non-cumulative NASDAQ breadth produces results far more predictive of actual NASDAQ performance.

I wrote to Babak about the reasons for this, and he described an exchange he had with master technician Helene Meisler from The Street.com about the weirdness of NASDAQ cumulative breadth. Meisler agreed, and her working hypothesis is that, over the years, the NASDAQ has grown itself through a steady flow of putrid, weak IPO's, a problem that the NYSE hasn't had. As a stock exchange, the NASDAQ has cumulatively become the worst of the worst, while the NYSE -- with its stricter standards -- is the creme de la creme.

So, breadth really does matter, but with the NASDAQ it helps to account for some of the garbage. The way to do this is to track NASDAQ breadth not just with NASI alone, but with non-cumulative A/D data as well. Stockcharts provides such a chart ($NAAD), which I smooth with moving averages.

Below are 3-year comparison charts of weekly NASDAQ A/D data vs. NASI. The difference between the two is obvious, and the results offer revealing insights into the current NASDAQ strength. I track daily versions side-by-side here.

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