Nvidia’s huge earnings beat sent the stock above $1,000 for the first time last week.
Nvidia is the third largest stock in the S&P 500 by weight. So the gain also drove the index to new all-time highs.
But there’s just one problem…
At the same time, most other stocks were going in the other direction.
That pullback in stock market breadth is a big problem for the bulls.
Breadth refers to how many stocks are participating in the market’s trend. When participation starts dropping, it suggests a reversal could be around the corner.
So today, let’s look at why you should remain cautious about the recent rally…
Participation in the Trend
There are lots of ways to measure stock market breadth.
One of the simplest and most effective methods is to look at how many stocks are making new 52-week highs compared to the number making new 52-week lows.
If you subtract the difference between those figures, you get something called net new 52-week highs.
The rationale for following this metric is straightforward. If the stock market is making new highs, then you expect to see far more stocks making new highs versus new lows.
That shows strong participation in the uptrend.
When the opposite is happening, though, that can be a major red flag.
Consider what happened near the end of 2021.The chart below plots how many stocks were making new highs versus new lows back then across the major exchanges.
The S&P 500 was hovering near the highs in mid-November of that year. But net new highs took a sudden dive into negative territory (black arrows).
The number of stocks making new 52-week lows started outpacing those making new highs.
The S&P went on to make a new high in early January 2022, but net new highs hardly recovered.
From there, the S&P 500 plunged during 2022’s bear market, with a 25% decline from the peak.
With that warning in mind, I’m closely following recent developments in net new highs.
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The Rally’s Crumbling Foundation
Now take a look at net new 52-week highs over the past nine months:
There are two things you need to watch.
First, the S&P 500 has been making new highs since earlier this year. And the number of net new highs has mostly stayed in positive territory.
But that’s changed recently.
There was a sharp drop into negative territory when the S&P 500 pulled back 5% in mid-April (red shaded box).
That might not seem surprising since the S&P 500 was declining. But the index was nowhere near making a 52-week low.
That shows the average stock was in a weaker position.
More recently, the action last week produced another red flag. Following Nvidia’s earnings release, the S&P 500 opened at a new record high.
But the net new highs dropped into negative territory, as you can see with the arrow. Remember, that means more stocks were making new lows than new highs.
Take another look:
So underlying participation in the stock market rally is deteriorating.
And that means we should remain cautious, even if the market doesn’t immediately show weakness. The current rally could continue for some time.
But it’s like trying to construct a new building on a shaky foundation.
It may hold up for a little while. But if the foundation isn’t fixed quickly, the structure is at risk of breaking down.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict