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12 Days of Christmas – Day 6

12 Days of Christmas – Day 6

| May 01, 2018

As a reminder, this is number six in our twelve month series about technical analysis.  It is a condensed version of a series that ran in one of our major providers in December called, “The 12 Days of Christmas.” 

One indicator that provides an aggregate picture of supply and demand themes across a large sampling of US stocks is the NYSE Bullish Percent Indicator ^BPNYSE.  The Indicator has history back to 1955, and measures the percent of stocks that trade on the New York Stock Exchange (NYSE) that are on buy signals.  That reading is plotted on a Point & Figure chart which goes from 0% to 100%. 

We look at this chart as one of our main “coaches” telling us whether the offensive team or the defensive team is on the field.  When the chart is in X’s we know that the number of stocks giving new buy signals is increasing, and as a result, the offensive team is on the field focusing on wealth accumulation strategies.  When the chart is in a column of O’s, with an increasing number of new sell signals and supply gaining the upper hand, we deploy the defensive team to focus on wealth preservation strategies for the portfolio. 

In addition to offense vs defense the BPNYSE also lets us know what our field position is to help narrow down what type of “plays” we should run.  There are two lines of demarcation, 30% and 70%.  A move to the 30% level or lower is considered the “green zone” with relatively low risk.  Conversely, the 70% level or higher is the “red zone” with high risk.  The availability of demand to push the market higher is limited at these levels.  Typically this indicator gets to these extremes only once every 3 to 4 years.

Bullish Percents & DALI:

As you can see in the slide above, the Bullish Percents are not designed to tell us the direction or magnitude of the market's move, but rather provides an indication of where the market is today based on participation rates, ie: percent of stocks on buy signals.  Since the ^BPNYSE measures the percent of NYSE stocks that are on a Point & Figure buy signal, a column of X's indicates increased upside participation on a stock-by-stock basis, and we would approach our equity positions with a general sense of offense, with a focus of wealth accumulation.  A column of O's indicates narrowing participation, putting the defensive team on the proverbial field and switching our near term goals toward wealth preservation.  This means it is time to review your holdings.  If we own positions that have completed consecutive sell signals or taken out significant support, we should consider selling with the change in risk.  We would also identify viable stop loss points in positions that remain in the portfolio.

Some find comfort in simply raising cash when the bullish percent moves to a "red light".  This is a sentiment that will not change for some advisors.  It is what allows them to sleep at night, acting as a fiduciary for client assets in a high risk market environment.  However, the data below makes the case for an alternate approach toward using risk barometers such as the NYSE BP.  When the bullish percent is on defense, but the US equity asset class is ranked #1, markets tend to hold up just fine.  When the asset class moves out of favor and markets are on defense, a very different story often unfolds.

We have looked very specifically at defensive periods in "strong markets", and defensive periods in "weak markets".  For this study we determined a "strong" market to be any time when Domestic Equities were ranked #1 or #2 in Dynamic Asset Level Investing (DALI), while a "weak" market was any period where US Equities were ranked #3, or lower.  As you can see, when the BP is in O's when US Equities are leading in DALI, the market trends to ride out any short term weakness reflected in the BPNYSE.  In fact, the average return for the S&P 500 SPX is 2.30% during those environments, dating back to April 2000.  However, when we see the BPNYSE in O's and US Equities are in a state of weakness in DALI, ie: ranked below the top 2 spots, we often see negative action for the major indexes, as the SPX recorded a -1.16% loss on average during those periods. 

Turning Points:

As you can see in the study above, reversals into O's for the ^BPNYSE when Domestic Equities are a "weak" asset class has helped to mitigate some of the most devastating market declines since 1999.  That said, when the market has experienced those market declines, the Bullish Percent provided objective guidance, along with the other indicators and tools that we use, during the market turning points.  Notice how the NYSE Bullish Percent dropped below 30% during the major market declines.  When the indicator reaches those levels, that's the time when the market feels at its worst.  Most equity prices are in the red, the headlines are extremely bearish, and people are worried.  So objectivity and guidance is needed.

Looking back over the last 20 years, we can easily identify five previous time frames (see chart below) in which the BPNYSE has fallen into the green zone, below the 30% level.  

1998 - As the “Asian Flu” spread to US markets, the BPNYSE had fallen to 20% by August of 1998.  The initial reversal occurred in September, and took the indicator up to a reading of 32%.  There was a “retest” as the indicator returned to O's that was ultimately resolved with a higher bottom at 24%.  By early November the BPNYSE had rallied to 60% as demand quickly returned to equities. 

2001-2002 - The tech bubble reached a peak in early 2000, and by 2001 the effects of the burst were being felt across the market.  The column of O's that began in June of 2001 was hastened by the terrorist attacks of September 11th, and it fell below 30% later in the month.  From October of 2001 through April of 2002, the BP rallied nicely and higher prices were achieved across the major market indexes; but by the summer of 2002, the indicator found itself back in the green zone at 24%.  A lower top was made in August, followed by a retest at 24% in October of 2002, just as the Nasdaq Composite found a bottom.  The reversal back in to X's in mid-October, ultimately led to bull confirmed status (a buy signal) on the BPNYSE by November.  Participation continued to expand throughout the equity landscape in to early 2004, when the BP chart found a peak at 86%.   

2008-2009 - This was a frustrating time for the Bullish Percent indicator as the unruly volatility led to an oscillating pattern on the chart.  In fact, the chart moved below and back above the 30% level a total of 4 times from January through November of 2008.  A few retests of previous lows were made during this time, some managing higher bottoms and some falling further than previous lows.  It was also during this period that the BPNYSE hit a new all-time low at 4% in October of 2008.  It wasn't until March of 2009 that the S&P 500 found a bottom, even though participation began to increase in late 2008.  By December of 2009 the indicator had moved back to bull confirmed status, and maintained that status for the next 14 months.

2011 - The BPNYSE found a high in January of 2011 at 80%, but spent the remainder of the year making lower tops and lower lows.  A bearish pattern like this on an indicator chart tells us that leadership is narrowing and that fewer and fewer stocks are able to participate in bounces.  The initial move below 30% happen in August of 2011, shortly after US debt ratings were downgraded for the first time.  An initial reversal followed later in the month, but as the European Debt Crisis came to a head, selling pressure became even more widespread and the bullish percent reading fell to 18% in early October. 

2015 - 2016 - The BPNYSE began descending after peaking in March and May of 2013 and continued in that path through 2015.  That's why it's important to remember that it's a "participation" indicator.  Even though markets were moving higher during that time period, not all stocks or sectors were leading the indexes higher.  Then when Energy prices collapsed and volatility entered into the market, the BPNYSE fell along with it and dropped below 30% in August of 2015 (another factor was the August of 2015 "flash crash.") That said, the indicator bounced back up above 30% in November, but the stay was short lived, as it moved back below 30% in January of 2016 as well as gave a sell signal.  The market rebounded that February and snapped back from 20% all the way up to 66% by April of 2016.  In January of 2017, the BPNYSE reached 68%, almost crossing back above the 70% threshold for the first time since July of 2014. 

Reversals up from below 30% do not occur often, and as we reported above, they do not resolve themselves in a similar manner each time.  In some instances, like August through October of 1998, the resolution is quick, straightforward, and to the upside.  During times of increased volatility (which causes back and forth action on individual charts), like we had in 2008, there may be a few “fake outs” before follow through to the upside is sustainable.

This discussion of Bullish Percents was long and involved.  You are probably thankful that you do not need to keep track of it all.  But please be assured that Bullish Percent indicators, as well as many others, are things we follow every day.  Our goal is to maximize your risk-adjusted returns by minimizing the risks in your portfolio.  As always, please call me if you have any questions.

Until next time, cheers!


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