The Daily Breakdown looks at the recent rally to all-time highs in the S&P 500 and how market breadth was a clue to the big rally.
Friday’s TLDR
- Market breadth remains strong.
- Breadth can give clues on the investing landscape.
- The XLC ETF just hit new highs.
The Bottom Line + Daily Breakdown
There are a lot of ways to measure breadth in the stock market.
Investors can look at the number of new highs vs. new lows. They can look at the number of stocks that are trading above or below a key moving average — like the 50-day moving average. Or they can look at the up-volume on an exchange (like the NYSE) vs. the down-volume.
Some of these resources are readily available for free, like the information at the Wall Street Journal. Other measures take a bit more effort to build (like a custom script or spreadsheet).
Oftentimes, the market can be really confusing, while headlines and the media are constantly writing about risks and worries in the market. Although that doesn’t necessarily make them untrue, they tend to over-blow the short-term implications and neglect the long-term realities of owning stocks.
Follow the money
Oftentimes in trading, you’ll hear something along the lines of “price action trumps everything” — and for good reason. It’s hard to fight a market trend. Stocks will go up or down regardless of our opinion.
While equities do generally favor the upside over long periods of time, there are times when stocks defy reality only to be humbled shortly thereafter (the S&P 500 hitting all-time highs in February 2020 while Covid-19 spread from China to Europe is one such example).
That being said, it’s generally wise to “look under the hood” for the market. That is, look at what stocks are telling us. After all, this is a “market of stocks” and how they are behaving can be key to knowing whether we’re in a healthy environment or an environment under duress.
What does breadth look like now?
Thursday was a huge day for the markets. That’s as the S&P 500 rallied 1.7% and the Nasdaq 100 climbed 2.6%.
That’s after the Federal Reserve cut rates by 50 basis points on Wednesday afternoon — even though the reaction wasn’t quite so clear on Wednesday, when both indices finished slightly lower that day.
Despite the fall, look at the number of new highs vs. new lows in the index on Wednesday.
While the indices fell, the individual action among stocks was decidedly more bullish. Of course, that wouldn’t have meant that stocks couldn’t have fallen on Thursday or that we were guaranteed to have a big rally the next day.
But it did tell us that investors weren’t panicking. Before the markets break down, we’ll need to see more stocks hitting new 1-month and 3-month lows — and we’ll need to see more of them than we see new highs.
The bottom line: It’s just one exercise but knowing what stocks are doing can help give us confidence in what the market is actually doing — even when it feels like it’s going to do something else.
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The setup — XLC
The communications sector broke out to a new record today, with the XLC ETF hitting an all-time high.
For months now, the XLC has been struggling with the $88 level. Each time, it has acted as resistance, sending the ETF lower. However, this time it was able to clear this level, as you can see below:
XLC bulls can justify staying long the ETF so long as it remains above the prior resistance zone of $87 to $88. If it can do so, the ETF could chug higher. If support breaks, then active investors can consider exiting the position with minimal losses.
Fundamentally, earnings are expected to grow at a solid pace. Bloomberg estimates call for double-digit growth in five of the next six quarters, with average growth of 14.3% over that span.
Meta and Alphabet are the top holdings for the XLC ETF, followed by AT&T, Charter, and T-Mobile.
Options
Options could be an alternative for investors who want exposure to XLC, but are nervous to get long. Remember the risk for options buyers is tied to the premium paid for the option — and losing the premium is the full risk.
Bulls can utilize calls or call spreads to speculate on further upside, while bears can use puts or put spreads to speculate on the gains fizzling out and XLC rolling over.
For those looking to learn more about options, consider visiting the eToro Academy.
Disclaimer:
Please note that due to market volatility, some of the prices may have already been reached and scenarios played out.