Downside Risk Escalates As "New Highs" Falter

Submitted by Eric Bush via Gavekal Capital blog,

We have had a nice little bounce in the equity market over the past two and half weeks. Since making a multi-year low on 2/11, our GKCI United States Index has rallied by nearly 7%. From the May 2015 peak to the February trough, the index fell by almost 16%. So has the latest rally kicked the equity market correction to curb and have equity markets entered into a new bull phase? Unfortunately, one of the more reliable market internal data points is indicating to us that there is probably further downside ahead in the short-term for investors.

When at least 55% of US stocks are making new 20-day highs, this is a sign that the overall asset class is in demand and that stocks are being widely bought. In other words, this is a sign that equities are in a bull market and investors should be participating. In the chart below, we plot new 20-day highs against the GKCI United States Price Index and we have added a line at 55% to mark when new highs hit this threshold. Granted, this indicator missed the 06-07 rally (perhaps a sign of the narrowness of that bull market), but otherwise it has generally been correct in identifying when stocks are in a bull market.

One of the reasons we are holding back our enthusiasm for this latest rally is the fact that new 20-day highs only reached a peak of 33% last week and have since fallen to just 22%. This is a sign to us that the distribution phase of the correction isn’t over yet and the market hasn’t moved into a broad accumulation phase.

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In addition, not only are we not seeing an expansion in new highs in the US, we aren’t seeing it anywhere in the world. New 20-day highs hit just 31% in this latest rally in Japan, 27% in the UK, and just 23% overall for all stocks in the developed market.

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When the market finally makes the bullish turn in earnest, we expect new 20-day highs to be an early sign post that we are headed in the right direction.