Integrating Fundamental Breadth and Technical Breadth to Diagnose Market Strength
Introduction
Seasoned traders recognise that true market strength is multidimensional. Raw price alone seldom tells the full story. Under-the-surface participation (breadth), earnings momentum, and balance-sheet resilience must corroborate each other for rallies to remain durable. This article presents a top-down diagnostic blueprint that fuses fundamental breadth—aggregate earnings and balance-sheet trends across the investable universe—with technical breadth—cumulative price and volume behaviours—to determine whether a market advance is powered by substance or froth.
1. Map the Fundamental Tide Before Surfing the Technical Waves
- Aggregate EPS Revision Diffusion: Collect consensus earnings-per-share (EPS) changes across all constituents in your benchmark. A sustained positive diffusion above +20% signals broad-based earnings confidence—an indispensable backdrop for persistent bull phases.
- Net Debt-to-EBITDA Spectrum: Pull net-debt-to-EBITDA for every firm, bucket them into quintiles, and observe whether the rally is carried by highly leveraged or conservatively financed cohorts. When low-leverage quintiles outperform, credit risk appetite is healthy rather than reckless.
- Free-Cash-Flow Yield Breadth: Create a rolling median free-cash-flow (FCF) yield for the top and bottom deciles. A bull move accompanied by compression of the dispersion—top-decile FCF yields falling faster—implies investors are rewarding quality fundamentals, not chasing low-quality cyclicals.
2. Overlay Technical Breadth Indicators
- Advance–Decline and Up/Down Volume Lines: Confirm that new highs in the index are matched by highs in cumulative advance–decline and up/down volume lines. Divergences foreshadow exhaustion.
- Percentage of Stocks Above Key Moving Averages: Track fractions above the 50-, 100-, and 200-day EMAs. Robust markets typically have >70% of shares above the 200-day. Cross-reference with FCF-yield strength.
- Rolling 20-Day High/Low Diffusion: Count daily 20-day highs versus lows, creating a diffusion index akin to the EPS model.
3. Build a Cohesive Market-Strength Dashboard
Blend all metrics into a weighted composite score:
- Fundamental Diffusion (EPS): 25%
- Net Debt Quintile Return Spread: 15%
- FCF-Yield Dispersion: 10%
- Technical Breadth Score: 30%
- Volatility Regime (VIX Z-Score): 20%
A composite score above +0.5 typically aligns with one-month forward gains >1.5× the long-term mean; below −0.5 suggests defensive allocation.
4. Translating the Dashboard into Stock-Picking Filters
- Top-Down Gate: Only deploy trades when the strength score is >+0.5.
- Fundamental Screen: Within strong backdrops, favour stocks with rising EPS revisions and improving net-debt metrics.
- Technical Trigger: Act when the stock shows a bullish breakout with positive breadth oscillator confirmation.
- Risk Budgeting: Use VIX Z-score to adjust position size inversely to market stress.
5. Case Study: 2023–24 AI Hardware Boom (Hypothetical)
During Q2-2023, EPS diffusion for semiconductor equipment hit +35%. Low-debt cohorts led, 80% of SOX names were above their 200-day EMAs, and 20-day high/low diffusion spiked. The composite score reached +1.4, triggering buys in quality chip-equipment stocks—capturing a 40% gain while avoiding overleveraged names.
Conclusion
Market strength analysis is not binary. Only when fundamental and technical breadth converge should capital be deployed confidently. This integrative approach helps traders align conviction with resilience, preserving edge while managing risk.
