By Paul Shread, CMT
The stock market managed to make it through the weakest part of the four-year cycle without a bear market — and a single indicator could be the biggest reason for that.
The NYSE advance-decline line never broke down this year as it did in 2007. In fact, it continually made new highs this summer even as the stock market was slow to recover (see chart below). If the market has broad-based strength, it’s hard for sell-offs to become much more than garden-variety corrections.
The current Dow Theory signal remains the buy signal from June 2009. Some called the cycle of lower highs and lower lows set by the Dow and Transports this summer a sell signal, but the June rally in the indexes wasn’t long enough to count as an intermediate term move (see charts below).
Martin Pring, author of “Technical Analysis Explained,” takes the view that a reaction should be at least a month in duration, so there was no Dow Theory sell signal on the subsequent new lows in July. Pring’s conservative approach to Dow Theory works well, so his rules bear restating here: Both the Industrials and Transports must confirm a new trend with an intermediate move in a new direction followed by a one-month reaction and then new highs or lows in the new direction. Simple but effective.
We are now entering the strongest part of the four-year cycle for stocks, so stocks should be able to avoid significant weakness over the coming months. However, it’s not clear if sentiment will allow significant upside from here. The weekly Investors Intelligence survey, which has provided reliable sentiment data for 40 years, is showing a high level of bullishness already (45-24 bulls to bears), so the market may have already seen a good portion of its rally off the midterm election year low that was likely set in early July.
Paul Shread is a Chartered Market Technician and co-author of the book “Dow Theory Unplugged: Charles Dow’s Original Editorials and Their Relevance Today” from W&A Publishing.