Sector Internals: Determining Industry Sentiment
The Market Navigator platform delivers our proprietary sector internals data in top-town market-by-sector analysis tools (Sector Ranking Tables and the Visual Sector Heatmaps). These provide strategic insights into sector rotation and market dynamics, and are also used to screen for momentum or contrarian opportunities as well as generally generating investment ideas.
In addition the data are provided in chart form for sectors and industries, as part of a tactical toolset that improves returns by enabling better position entries and exits. These are used by portfolio managers and traders on a standalone basis, together with our top-down tools, or as an overlay for existing strategies that does not impinge on existing investment processes.
The sector internals based charting tools are accessed by clicking the 'Sector Charts' button in the Market Navigator controls (see A3 in the controls overview), and selecting the desired chart period from the 'Options' drop-down menu (short term/long term).
Interpreting Sector Advance Decline Lines
The Sector Advance Decline (A-D) Line is a key barometer of sector health, defined as the cumulative daily number of advancing less declining stocks.
In this way the A-D Line reflects the performance of the average sector constituent - rather than of large cap components that can skew market cap weighted indices - highlighting whether sector sentiment/market appetite is broadly improving or deteriorating.
The A-D Line at the exchange-wide level is traditionally viewed as a measure of confirmation that should closely resemble the shape of the price index; if this is not the case. it is a red flag that accumulation or distribution may be occurring as a precursor to a change in trend.
However, whereas NYSE data contains a significant proportion of preference shares and structured products typically correlated with fixed income that can distort interpretation, MarketScalpel's sector breadth data reflects purely the performance of common equities; unlike NYSE data, our total US market A-D Line did not exhibit false positive divergences from early 2001 to March '03 .
The A-D Line is an indispensible indication of sector appetite, the value of which was for example demonstrated by its forecast of a deterioration in sentiment in US banks early 2007.
Percent of Stocks Above Key Moving Averages
MarketScalpel's sector structure and analytical framework provides another effective way of determining sector sentiment; quite simply we measure whether it is increasing or decreasing by reference to the percentage of sector components trading above the 10, 25, 50 and 200-day moving averages of their respective share prices.
These time series typically reveal empirical levels from where price reversals tend to occur varying from sector to sector. In this way clients with multiple investment horizons have access to advance warning of natural low risk areas for position entries and exits.
It should nevertheless be noted that whereas lows in sector price indices are for the most part coincident with bottoms in these time series, tops typically fall with a lag due to internal sector leadership becoming increasingly narrow prior to the final exhaustion of an advance.
We divide the four time series into two broad groups:
Short Term Series: Percent above 10/25-day MAs
Aside from the obvious usefulness for short term traders, these levels may be
used to build positions within the context of established longer term trends, or
alternatively progressively trim them when longer term measures or the
cyclical
picture indicates that a tradable reversal is approachingIntermediate/Long Term: Percent Above 50/200-day MAs
These indicators reveal empirical low risk areas for longer term position entries and exits, and may be used in conjunction with the shorter term series, and the sector stock tables to identify leadership in the absence of for example fundamental research.
Sector Components at 52-week Highs & Lows
The percentage of sector components trading at or near 52-week highs/lows is a key indicator of the availability of momentum returns (see for example Hwang & George, 2004) and may be screened for using the Market Navigator top down analysis tools.
In addition, these metrics should be watched as important indicators of trend confirmation for validating investment theses regarding existing and contemplated positions. Since internal sector leadership narrows prior to a reversal of trend, the number of components at new 52-week highs/lows should ideally expand in the direction of the trend. If there is instead a loss of momentum it is a precursor to a possible reversal.