At this point in the year, the volume on the exchanges goes down, traders go on vacation, and we’ll spend the next five months in the “Seasonally Weak” months of the year. Normally, these summer doldrums cause tepid performance in the markets, but that’s just not what I’m seeing right now. Whether you’re an investor who’s “all-in” right now, 100% invested in stocks… or better yet, if you’re someone who’s still sitting on your hands, waiting for the crash to occur before you invest, you need to see the chart below and read the rest of this, short educational piece.
Before I explain the analysis in the chart below, I need to re-explain an analogy I’ve discussed in past articles; and that is the concept of “Generals and Troops.”
The Generals are the big, large-cap, blue chips stocks. We’re talking Apple, Coke, Disney, Goldman Sachs, Exxon, Johnson & Johnson, McDonalds, and a bunch of other behemoths.
The Troops are the much smaller, micro and small-cap companies that most people have never heard of. For example, the troops consist of companies such as Axon, Chegg, Tiptree and Tailored Brands.
With that behind us, do you know how many small company stocks are on the Dow?
What about the S&P 500, which is a much larger, maybe not perfect, but better representation of “the stock market,” are there small companies in the S&P 500?
But… are they equally represented when the S&P 500 goes up or down each day, week, month, or year?
So, the Dow is only 30 stocks, and all 30 are large company stocks. The S&P 500 is a mix of big and small, but the majority of the movement (up or down) of the index is largely a representation of what the bigger companies are doing. The performance of the smaller companies is hardly obvious.
The NYSE (New York Stock Exchange) Composite Index is comprised of more than 1,900 stocks, 1,500 of which are in the U.S., so it’s a good representation of what’s going on in the market. Still, it’s cap-weighted, just like the S&P 500 – so again, the big companies are the Generals and represent most of the movement you see every day as the market goes up and down. The Troops, again, get no love.
If you scroll down for a quick second, you’ll find a chart of the NYSE Composite Index, but I’ve included what I feel to be the most important indicator of market health just below it… the NYSE Advance/Decline (or “A/D” ) line. The A/D line is simply a daily calculation of (Total # of Advancing Stocks) – (Total # of Declining Stocks), and it’s then plotted on a chart to create a line graph that we can use to identify highs, lows, and trends.
So to take things one step further, by using the A/D line, we can see how MANY stocks are going up or down and compare this ratio to the NYSE index, which is primarily dominated by the Generals.
<Nerd’s Note: There are two A/D lines for the NYSE – one is the NYSE A/D and the other is called the NYSE A/D Common Stocks Only (CSO). I like to use the CSO version because a good number of the investments on the NYSE are actually bonds and derivatives, which don’t give us a good representation of what the stock market is doing. Thus, using the CSO rendition takes the metaphorical mud out of the water, showing me only stocks with no bonds, etc..>
Below in the upper-pane, you can see that, much like the Dow and the S&P 500, the NYSE Index peaked in late-January, bottomed in early-February, re-tested the February lows in late-March, but it still hasn’t managed to break north of the intermediate February and March highs, let alone re-trace back to the January highs.
On the other hand, if we dig deeper and perform proper inter-market analysis, we can find (in the lower-pane) the NYSE A/D CSO line, which tells us not what the total aggregate PRICE of the NYSE index is doing… no. It equally-weights all the Generals with the Troops, so that we can see how MANY stocks are going up vs. those that are going down. As you can clearly see:
- While the NYSE Index (upper-pane) printed a lower low in late-March/early-April, the A/D line printed a HIGHER-low.
- In mid-April, when the NYSE printed a LOWER-high, the number of stocks advancing actually went UP, not only printing a higher-high, but it broke north of the January highs, before falling back temporarily.
- And then, in mid-May, when the NYSE index still couldn’t reach the March/April highs (let alone the January highs), the A/D line broke out above the January highs again!
What does this all mean? It means that the stock market is deceiving you! While it looks like prices are headed lower and that a recession is around the corner, the truth is, we’re seeing more stocks going up than stocks that are going down! To put a cherry on top – it’s the small companies (the Troops) that are leading the way… and it’s pretty difficult to have a market crash when the smallest companies are the ones producing the most gains.
The lesson of the day: Know what to look for, pay attention, and ignore the news.
I hope you have a fun, long, relaxing Memorial Day weekend and we hope to hear from you soon!
Till next time…
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* Adam Koos, CFP® is a CERTIFIED FINANCIAL PLANNERTM Professional, as well as president and portfolio manager at Libertas Wealth Management Group, Inc., a Fee-Only Registered Investment Advisory (RIA) firm, located in Columbus, Ohio.
The opinions mentioned in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial adviser and strongly consider interviewing a fee-only financial advisory firm, prior to investing. Past performance is not guarantee of future results. Economic forecasts set forth may not develop as predicted. The views and opinions expressed in this commentary are those of Adam D. Koos, CFP® and do not represent the views of TD Ameritrade Institutional and its affiliates. Investing involves risk including loss of principal.