When advance-decline confirmation counts the wrong universe

What the daily line is testing

A conventional daily advance-decline line is a running total of each session's net advances minus declines. That running total is then compared with the averages to test whether most issues are participating.

A new high in the averages that is matched by a new high in the advance-decline line is treated as healthier participation. An unmatched new high is treated as more vulnerable. That mismatch is used especially when studying tops.

One listing, two breadth universes

Two parallel daily advance-decline series can be built from the same exchange listing. The common-stock breadth universe is limited to common stocks, so rate-sensitive preferreds and bond-fund shares are left out. The composite breadth universe also includes preferred stocks, closed-end funds, warrants, rights and other share types.

Through 1990 the common-stock and composite advance-decline paths tracked closely. After April 1991 they diverged, with the composite printing three higher highs and three higher lows while the common-stock series posted lower highs and lower lows during 1992.

On 10 March 1993 the composite advance-decline line stood 13.23 percent above its 17 April 1991 high, while the common-stock-only line stood 2.11 percent above that same high.

When the listing mix tracks bonds

In that early-1990s listing mix, about one-third of exchange issues were described as more sensitive to the bond market than to the stock market. That rate-sensitive listing mix included roughly 19 percent preferred stocks, 11 percent closed-end bond funds up from 2 percent five years earlier, and about 2.5 percent electric utilities.

The split between the two advance-decline series was tied to an initial-public-offering surge after the first-quarter 1991 rally together with a drop in short-term yields from above 7.5 percent to below 6 percent that encouraged issuance of closed-end bond funds. Intermarket spillover into breadth is the way that yield drop can lift preferreds and bond funds and thereby inflate a composite advance-decline line that is then read as stock-market health.

A preferred-stock advance-decline line over the two years after April 1991 closely resembled the exchange bond advance-decline line. That resemblance was used as confirmation that about 30 percent of listed shares were tracking the bond market rather than the stock market.

Confirmation from the mixed count

When the exchange composite index broke out to new highs in November 1991, the composite advance-decline line confirmed that breakout just before a sharp reversal. The common-stock-only line never confirmed it.

After the 10 March high on both advance-decline lines, the common-stock-only series began to lag. Two-to-three-month divergences between a daily advance-decline line and the major averages were described as the more reliable window in that historical sample.