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The State of the Markets |
With the S&P 500 having declined a smidge less than 5% from its recent highs, we’re guessing that there are two questions on investors’ minds these days. First, will we see more downside in the near term? And second, will there be more upside after this corrective phase ends?
In hunting around the office, I’ve come to the conclusion that our trusty crystal ball must still be in the shop. I’m not sure if it was able to be repaired or who was responsible for picking the thing up, but unfortunately, I won’t be able to provide much of a prognostication on the first question without it.
However, we can take note of a few points that may help us frame an opinion going into the next week. First, at -4.33%, the current pullback is the most severe we’ve seen in the last three months. And at eight trading days in length, it is also the longest corrective phase we’ve seen since mid-June. We should also point out that the indices are now oversold on a short-term basis and that only the 50-day moving average is still intact after the recent dance to the downside.
The bears will try to argue that all of the above, when coupled with the less-than inspiring economic data seen over the past week or so, means that a more defensive mood has engulfed Wall Street. And given that the short-term trend is now pointing southward, our furry friends suggest that we could easily see some additional selling.
Yet, the bulls have a few points of their own to make. Our heroes in horns argue that the intermediate-term trend remains up and they point to the pattern of higher highs and higher lows on the charts as proof. On the economic front, the bulls are also quick to scold anyone silly enough to think that the data is going to be all peaches and cream going forward. They say that the recovery will be uneven, that we’ve got to take the good with the bad, and that we should pay attention to the overall big-picture trend of the economy, which is improving. And finally, the glass-is-at-least-half-full crowd says there is a decent chance that earnings are going to continue to impress.
So, from a short-term perspective, I guess you could say a coin flip would be a fair way to assess the situation. But gun-to-the-head; a bounce followed by some additional selling (or the other way around) would seem to make sense about now.
I should probably apologize for all the waffling on the near-term outlook. But hopefully you caught the point that the short-term movements in the market are always tough to call and really don’t have that much bearing on portfolio performance in the long run. However, from a longer-term perspective, we can say that we believe there will indeed be more upside ahead.
Over the past six months, we’ve talked a fair amount about something we like to call a ‘breadth surge buy signal.’ The idea is that when the 10-day total of advancing issues swamp the number of declining issues by a measure of 1.9 to 1, it is reasonable to assume that the market is surging forward. History (and the computers at Ned Davis Research) shows that this signal has very positive implications for the stock market over the next three, six, and twelve months.
The good news is that the most recent run for the roses produced another breadth surge buy signal on September 16th (the third this year). And as we’ve pointed out in our previous reviews of this particular buy signal, the odds strongly favor higher stock prices three, six, and twelve months after the buy signal. In fact, of the 30 signals that have been given since 1947, NDR tells us that the S&P 500 has been higher three months later 24 out of 30 times. Six months after the signal, the S&P has been higher on 27 occasions. And one year later, the S&P has been higher 28 out of the 29 occurrences.
Another pretty solid way to assess the strength of a market move is by looking at the number of stocks that are able to move above their 50-day moving averages. The thinking here is that if the vast majority of stocks are trading above their 50 dma’s, then the breadth of the market is “in gear” and likely to stay that way for a while.
So, we checked with NDR’s computers to test out this idea and were quite pleased with the results. Using their Institutional Equity Universe (the most liquid stocks traded in the U.S.) we find that when 90% of the stocks were above their 50-day moving averages, good things tended to happen over the next year.
Going back to 1967, NDR reports that when 90% or more of the stocks in their institutional universe were above their 50 dma’s, the S&P was higher EACH and EVERY TIME over the next 30 days as well as the next three, four, six, and twelve months later.
Yep, that’s right – here’s a rather rare indicator (this is a rare occurrence as it’s only happened 10 other times before this year) that has a perfect track record for issuing buy signals – and it just went green again on September 16th. Thus, we’ll suggest that while there is always a first time for everything, it is probably a good idea to continue to give the bulls the benefit of the doubt for a while whenever things get ugly.
Finally, it is important to understand that corrections can and DO happen after such upside surge buy signals. Sometimes the corrections can be downright nasty. However, when the odds are stacked this heavily to one side, we like to take notice. Put another way, it probably isn’t a good idea to try and bet against the strength of this market just yet. And it is for this reason that we do not plan on using the short side of the trading game to any great degree in the near future.
David D. Moenning
Founder TopStockPortfolios.com
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