The stock market has been wobbly since last May, but it continues to hold up. My barometer – the NYSE advance-decline line (NYAD) – lagged from May until it broke out late last year, and it is leading the recovery this month. So while the long negative divergence last year was a warning sign, the new highs in the NYAD since then suggest that any decline may be limited, at least until the NYAD peaks before the rest of the market.
But as mid-term election years tend to produce important stock market lows (think 2002, 1998, 1990, 1982, 1974 and so on), and sentiment indicators like Investors Intelligence are showing a general lack of bearishness, I’d be quite surprised if the stock market escapes this year without a significant sell-off, perhaps even a mild bear market.
Dow Theory and breadth remain positive, however, so the warning signs do not appear dire for now. That doesn’t rule out even a 25% bear market, as happened in 1946 and 1976 without an NYAD divergence, but 80 years of stock market history suggest that worse than that is unlikely without deterioration in the NYAD first.
Paul Shread is a Chartered Market Technician (CMT) and co-author of “Dow Theory Unplugged: Charles Dow’s Original Editorials and Their Relevance Today.”