Over the past week my research feed has been filled with bulls celebrating the recent Zweig Breadth Thrust buy signal. At this point, you are probably nodding your head in agreement, or saying to yourself – “what the hell is a Zweig Breadth Thrust signal?”
The following article from Business Insider titled “A ‘Zweig Breadth Thrust’ signal just went off — and it’s super-bullish for the stock market” sums up the bulls’ argument and also explains a ZBT (as the cool kids call the signal):
At the close of trading on Thursday, a “Zweig Breadth Thrust” signal went off, and this is really good news for the stock market.
As Rob Hanna at Quantifiable Edges outlines, this is an indicator that has been triggered when the 10-day exponential moving average of stocks rising tops 61.5% after having been below 40% within in the past two weeks.
On Thursday, this ratio topped 63%, triggering the Zweig Breadth Thrust indicator.
In simpler terms, this roughly means that after fewer than two in five stocks were trending upward a few weeks ago, we now have closer to two-thirds of stocks in the market rallying. And so after momentum inside the stock market was negative not too long ago, this trend has notably and in a serious way reversed.
As Hanna notes, the Zweig Breadth Thrust indicator is named for legendary investor Martin Zweig, who among other things called that the market appeared headed for a crash on the Friday before the historic Black Monday of 1987, when the Dow fell 22% in a single day.
This is only the eighth time that the Zweig Breadth Thrust indicator has been triggered since 1970, and in all seven previous instances, the S&P 500 finished higher 20 days later, with positive readings in 1975, 1982, and 2009 all leading to 20-day rallies greater than 8%.
Got that? When the 10 day exponential moving average of stocks rising tops 61.5% after being below 40% within the past two weeks, it is time to BUY! BUY! BUY!
Far be it from me to rain on the bulls’ parade, but let’s take a moment and really think about what a ZBT means. In layman’s terms; during a period with few rising stocks, it suddenly flips with a massive broad based buying frenzy, then a ZBT is triggered.
The legendary Martin Zweig devised the signal, and it has indeed had a great track record. But according to Quantifiable Edges, the signal is actually quite rare:
Over the past 45 years, the signal has only triggered seven times.
Have a look at those dates. Many of those triggers were the start of big bull markets.
But do you really think we are on the cusp of a new bull move? We have been rallying for the past 6 years. We are up over 200% since the lows. This is the point to get all bulled up?
As per yesterday’s post, I think markets have changed. Central Bank direct intervention has distorted risk asset market signals.
Earlier in the year one of my favourite hedge fund managers, Stanley Druckenmiller misread the Chinese stock market rise as a sign that the Chinese economy was about to take off. Druck did warn that there was a potential for the signal to be false, but I don’t see that same sort of humility from the ZBT’ers.
My take on the ZBT signal is that the Central Banks have rendered it less reliable. They have pushed risk assets to levels where at the slightest hint of the bid disappearing (which happened as the Fed tried to prepare the market for higher rates), traders immediately lean heavily on the short side. This is a natural reaction when prices are extended above their fundamental value. But this increase in short positioning results in vicious short covering rallies when the Central Banks flip their stance.
I don’t think you can trust these sorts of risk based market signals anymore. Risk assets are no longer trading of their “own free will.” Therefore these sorts of predictions from broad based rises are no longer valid.
Now maybe we rally from here, I am not ruling that out. But instead of counting the number of rising stocks, I would rather watch areas of stress that have been keeping the market down.
For the past six months I have been arguing the US economy (and stock market) could not handle the rising greenback.
This logic has finally sunk in at the Federal Reserve. The FOMC committee members are acknowledging at an unprecedented pace that the US dollar strength has been a much stronger than expected headwind. In this day and age of limited global growth, currency strength is a death knell for an economy. It happened to Japan in 2012, it happened to the Euro area in 2014, it crushed China this year, and it is only a matter of time before it seeps through to the United States. The fact that the US dollar rally has stalled, and might even be about to falter, might be a positive for risk assets going forward.
But it will be tough for stocks to rally if the credit markets continue to melt.
Credit spreads keep widening. Over the years I have learned the hard way that when bonds and stocks don’t agree, go with the bonds. The fact that spreads keep widening is troubling.
Over the past week there has been a small bounce, but look at this chart – it is terrible looking. This is not the stuff of a bull market. I don’t see how you can get all bulled up on risk assets with credit spreads widening.
Although some my technically driven brethren will place great faith in the Zweig Breadth Thrust buy signal, I will take a pass. Instead I will stare at the US dollar and credit spreads. Until they start giving different signals, I will err on the bearish side of stocks…
Thanks for reading,