Technically Speaking, November 2022

On page 1 of the CMT Association’s Constitution, our Mission statement is written (Article 2: Purposes). The Mission has three parts — strategic goals, really — which are equal in importance regarding the future success of the Association as we aim to be the standard-bearer of Technical Analysis worldwide. In this month’s President’s Letter, I want to explain further how we execute on the third item that composes our Mission:

Establish, maintain and encourage the highest standards of professional competence and ethics among technical analysts.

If you are a candidate in the CMT Program, then you are already very aware that the CMT Association partners with the CFA Institute to follow a single Code of Ethics and Standards of Professional Conduct. Since 2015, the CMT Association has licensed the CFAI’s well developed and highly respected Code and Standards for use in all three levels of our curriculum.

Moreover, CMT Association members must abide by the Code and Standards and are encouraged to notify their employer of this responsibility. All Members and CMT Program candidates must study and adhere to the Code and Standards without exception.

The Standards of Practice Handbook makes clear with the help of descriptive examples the proper course of action one should take to navigate many potentially confusing and ambiguous ethical situations that Members and CMT Program candidates may face. I highly recommend that all Members, regardless of how long ago you took the CMT exams, study up on the Code and Standards, at least to the degree that you are familiar with the seven (7) Standards and understand their meaning.

An additional resource for Members with which CMT Program candidates are already familiar is the CMT trademark guide. It is important to use your “CMT” letters properly, so we all maintain the excellent reputation of our discipline.

Another important requirement of Membership is maintaining your Professional Conduct Statement (PCS), which is an annual attestation you fill out when you become a Member and then must resubmit every year after when you renew membership. When you log into My CMT, click on “Membership” on the left navigation bar, then click the link that says “View / Edit PCS Statement”. The answers in the form default to “no”, but you are required per the Bylaws of the Association to refresh this form annually and make any necessary updates.

What happens if you don’t follow the rules? Well, the CMT Association staff monitors members’ behaviors for infractions and reports them to the Board as they occur. The Ethics Committee then evaluates the situation and makes recommendations to the full Board regarding possible sanctions, including revocation of the right to use the CMT designation and possible expulsion from the Association (yes, we take it very seriously).

Additionally, the CMT Staff and Board are assisted from time to time by members who alert us to violations. Honestly, this has been an extremely helpful way for the Association to self-police members’ actions. If you are aware of CMT Program candidates or members behaving badly, please follow this link to learn how to report what you’ve seen.

Would you be interested in serving on the Ethics Committee? If so, please send an email to [email protected], and your volunteerism will be shared with the Governance Committee and me, the President, for consideration.

Maintaining high ethical standards not only elevates the field of Technical Analysis, and improves our reputations with other financial professionals, but it also makes it easier for everyone to succeed in the field of Finance overall. Trust is the bedrock of efficient, liquid, and effective free exchange in global financial markets. By adopting common ethical standards and adhering to them, we improve our own chances of success.

The Technical Analysis community has a nearly endless number of loose definitions for what specifically constitutes a “Breadth Thrust.” While Technicians almost universally understand this term, it might confuse many investors about what this development is and how it can be utilized. To start, we need to go over what we mean by “breadth” before we dive into the Breadth Thrust development.

Put simply, “breadth” is either the number or percentage of index components or basket of assets per the user’s choice that are meet some type of specified criteria. For example, a commonly quoted breadth metric for the S&P 500 is the percentage of stocks trading above their 200-day moving average. It’s important to note that while the definition of breadth itself is quite specific, many financial news pundits will often refer to breadth as simply good or bad without providing any real context on what is measured.

“Breadth Thrusts” are technical developments whereby a certain number or percentage of index components or assets move from one reading to another (usually two opposite extremes) within a specified period. Notice that the operative descriptor here is “within a specified time period.” While many market technicians in the past have their own namesake breadth thrust indicators specifically defined in both conditions in the timeframe, investors can utilize any number of criteria to create their own thrust indicator to suit their preferred timeframe and risk tolerance.

Before diving into the test results, first, we must provide some context around market breadth. As an example, generally speaking, very high readings such as 80%, 90%+ above a moving average are often interpreted by investors as bullish. Paradoxically, very low readings such as 20% and 10% are often interpreted as “so bad; it’s good,” or a “washout” condition. However, these readings are often little more than data points when not presented in both historical context and the direction of the prevailing trend.

Historically, how has the market behaved when a breadth thrust has occurred? What happens if a breadth thrust occurs when the prevailing market trend is down? Or when the prevailing market trend is up? Utilizing specialized software, these are all valid questions that we can provide some degree of historical context around.

We will be looking at the S&P 500 as the universe. The conditions will be defined as the percentage of components in the S&P 500 that are trading above their 20-day (one-month) moving average. The “thrust” will be defined as readings moving from below the 20% mark to above the 80% mark within one month of trading. The primary market trend will be determined by whether the 200-day moving average of the index has a higher or lower value than the prior trading day—a higher value defines an uptrend, while a lower value describes a downtrend.

S&P 500 – 20 Day Breadth Thrust

For the S&P 500, there were 85 instances since 1982 where the percentage of S&P 500 components trading above their 20-day moving average moved from below 20% to above 80% within one month of trading for a median gain in the S&P 500 of 3.45%, with a 66.67%-win rate over the following quarter. Note that returns at the 20th percentile are coming in at a modest loss of -2.46%. It’s worth noting that median gains in the index have tended to peak 61 trading days out at 3.86% on an improved 70.24%-win rate over the following quarter. The green arrows in the chart represent the 20-day breadth occurrences; note that throughout various market cycles, breadth thrusts have occurred in both rising and declining markets.

*Data as of the close of business 10/10/22 via Optuma

S&P 500 – 20 Day Breadth Thrust in an Uptrend

There were 56 instances since 1982 where the percentage of S&P 500 components trading above their 20-day moving average moved from below 20% to above 80% within one month of trading while the S&P 500’s 200-day moving average was up for a median gain in the S&P 500 of 3.45% with a 71.43%-win rate over the following quarter. Note the 20th percentile returns coming in at a loss of -1.48%, the smallest 20th percentile loss of all three tests. It’s worth noting that median gains have tended to peak 59 trading days out at 3.91% on an improved 75.00%-win rate over the following quarter.

*Data as of the close of business 10/10/22 via Optuma

S&P 500 – 20 Day Breadth Thrust in a Downtrend

There were 29 instances since 1982 where the percentage of S&P 500 components trading above their 20-day moving average moved from below 20% to above 80% within one month of trading while the S&P 500’s 200-day moving average was down for a median gain in the S&P 500 of 3.72% with a 57.17%-win rate over the following quarter. Note the 20th percentile returns coming in at a loss of -4.54%, the deepest 20th percentile loss of all three tests. It’s worth noting that median gains have tended to peak 38 trading days out at 4.24% on an improved 79.31%-win rate.

*Data as of the close of business 10/10/22 via Optuma

Bringing It All Together

While many investors will point to the fact that a Breadth Thrust is often a carte blanche positive development, adjusting for the long-term trend has historically suggested otherwise. Note that when a 20-day breadth thrust has occurred in a downtrend, 20th percentile losses came in a -4.54% vs. -1.48% while in an uptrend, compared to -2.46% 20th percentile losses for all occurrences since 1982. Additionally, win rates for a 20-day breadth thrust in a downtrend were much lower at 57.14% vs. 71.43% in an uptrend, despite very similar median gains.

This is not to say that investors should never attempt to utilize a breadth thrust in a downtrend as a signal. In fact, the highest median gain across the three tests was a 20-day breadth thrust in a downtrend at 38 trading days post-signal for a median gain of 4.24%. Rather, this work is suggestive that not all breadth thrusts are created equal.

*Further work on this topic can be done on other breadth metrics, which may be more specific to the individual time frame of the investor.

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While gold has not done much in 2022 in terms of absolute returns, the SPDR Gold Shares (GLD) has indeed outperformed the SPDR S&P 500 (SPY) by about 11% year-to-date. Why has gold not done better as a safe haven? It’s all about the U.S. dollar.

First, let’s review gold’s role as a “safe haven” during bear market phases.

While gold has struggled in absolute terms, it has handily outperformed the S&P 500 Index ($SPX) year-to-date. GLD is down about 4% in 2022, while SPY is down 15% over the same time period.

If you had informed me at the end of 2021 that 2022 was going to be a raging bear market for stocks due to concerns about inflation, I would have told you that one of the surest bets would be gold. Gold is often considered one of the best inflation hedges around. So why has gold not been a better safe haven while equities have been in a consistent bear market phase in 2022? Quite simply, the strength in the U.S. Dollar Index ($USD) has prevented gold from fulfilling this traditional role.

Every month in 2022, the $USD has made a new high for the year… until October. The $USD has now made a pattern of lower highs and lower lows over the last six to eight weeks, indicating a potential change in trend. The relative strength index (RSI) for the $USD has now dipped below the 40 level for the second time in 2022. This move below RSI 40 may indicate a “change of character” from a bullish primary trend to a bearish primary trend. This short-term weakness in $USD has provided space for risk assets like equities and commodities to reverse their recent downtrends and push to the upside. Further weakness in $USD would allow risk assets, including commodities, to push higher.

For now, I’m watching the 105 level for $USD. That represents a 38.2% retracement of the May 2021-September 2022 uptrend and would be a reasonable downside objective given the recent weakness.

So what’s next for gold?

As the RSI for $USD has dipped below 40, indicating a new bearish phase is likely, the RSI for gold has pushed above the 60 level after spending most of 2022 below this level. That suggests a bullish primary trend as upside momentum has expanded.

The next upside target for GLD, using Fibonacci retracements, would be around $167, which is just 1.5% above Friday’s close. The 200-day moving average lies just above that level as well. If those resistance levels are violated, we could see further upside to the 61.8% retracement level to around $177.

In terms of spot gold, that would suggest resistance in the $1800 range, with the next upside target around $1900/oz.

2022, up until October, has been all about rising interest rates, a stronger dollar, and falling risk assets. If the seasonal tendencies hold up going into year-end, we may be facing a bullish run with gold in the driver’s seat!

Want to digest this article in video format? Head over to my YouTube channel.

I don’t know which direction the stock market – or any other asset class – is headed next. No one does for sure. But whether your portfolio is prepared for impending doom or positioned for equities to rocket higher, it’s always important to understand both the bull and bear cases. By understanding where the risks to your thesis are, you’re more likely to know when your thesis could be wrong. Only then can you take corrective action

With stocks on pace for one of their worst years ever, the bear argument isn’t hard to see. Trends are down in most asset classes. Inflation is running rampant, cutting into consumer savings and crushing consumer confidence. War rages in eastern Europe. China clings to a Covid-zero approach that continues to wreak havoc on global supply chains.

Central banks around the world are pushing for tighter financial conditions. Our own Federal Reserve started the year still doing quantitative easing, and their policy rate was at the zero lower bound. It’s since implemented the fastest interest rate liftoff in decades and begun reducing the size of its balance sheet at the fastest rate ever.

Earnings growth has weakened on the back of margin pressures and unrelenting Dollar strength, and economists almost unanimously forecast a recession within the next 12 months. Home sales have come to a complete stop. And let’s not forget those 2 consecutive quarters of negative GDP growth.

Like I said, it’s easy to be a bear.

So what’s the bull case? What signs should we be watching for a change in the trend?

I think it starts with the Dollar and rates. If you flip a year-to-date chart of the US Dollar index on its head and lay it on top of the S&P 500, you can hardly tell the difference between the two. The correlation with yields has been nearly as strong.

Only a few times this year have one of the three diverged from the others, and each time, the majority proved right. Right now, stocks are moving higher and the Dollar is moving lower, but rates have largely failed to confirm the move.

Last week’s bond rally did little to erase the prior 12(!) consecutive weeks of interest rate increases.

We’re looking for the bull case, though, right? And last week’s candle was a bullish engulfing one for 10-year Treasury notes. That could have marked a bottom for bonds that would confirm the move in stocks.

The rally will likely require further weakness in the U.S. Dollar. The USD hasn’t set a new high in over a month and is currently testing support. Failure to hold it would be a positive sign for bulls.

Equities have shown some strength in their own right.

The S&P 500 October lows didn’t quite reach the pre-Covid highs like they did for the Dow Jones Industrial Average. But the trough did occur at a pretty logical level: the September 2020 highs, which marked a major peak in Growth vs. Value. Prices have jumped 11% from their lows.

There’s been internal improvement lately, too. The S&P 500 index is back above its June lows, and so are most stocks. More than 70% of constituents are above those former lows, including 71% of Information Technology stocks and nearly every Energy company.

One group that isn’t above its June lows is Communication Services. This sector has been the worst place to be in 2022, down 38% since December. Yet even after it’s two largest companies disappointed investors last week and were punished accordingly, the sector overall closed the week above lows set earlier in the month. Moreover, daily RSI never even got close to oversold levels.

It could be that lows haven’t been broken yet, and momentum hasn’t gotten oversold yet. But the alternative hypothesis is that even the worst sector in the index has stopped going down. When that happens, the bears have lost their grip.

Here’s more evidence for the bulls: defensive areas of the market are no longer leading. The Utilities sector has been falling on a relative basis for the last month after being a leader for the first 9 months of the year. If that continues, it probably happens in a world where stock prices are rising, not falling.

So if it’s not defensive areas of the market that are leading, who is it? Obviously, Energy stocks have been a dominant force. But there’s relative strength elsewhere, too. Small cap stocks never even broke their June lows.

And neither did Bitcoin. What does that tell you about risk appetite?

The bears are still in control of the market, and it’s not hard to understand why. We never want to lose sight of the trend and right now, that’s still down. But the night is always darkest before the dawn. Stay vigilant.