Blast-Off Indicators
By
Michael Cintolo, Editor of
Cabot Market Letter and
Cabot Top Ten ReportFrom Cabot Wealth Advisory 5/11/09 Sign up for free
Cabot Wealth Advisory e-newsletterWhen it comes to market timing, I prefer to keep it simple, and that's exactly what my Letters do. For the most part, my timing is based on two things—the trend of the overall market, and the action of leading stocks. One pertains to the overall market's health, while the other tracks the stocks I usually focus on. Simple.
However, there is one category of indicators that I do track...though they generally give signals only every few years! Thus, you can't use these indicators to tell you when to get in or out of the market, and they're unlikely to be much benefit in your daily investing routine.
So why follow them? Because when they do flash green lights, it tells you something unusual is happening—something unusually bullish!
I'm talking about
blast-off indicators (I haven't thought of a snazzier name for them), and the concept revolves around a "super-overbought" market. Overbought is a term that refers to a market that's run-up for a few days in a row, and thus is commonly thought to have come too far, too fast. A pullback often ensues.
Most of the time, overbought-type indicators work pretty well for the overall market. (FYI: They generally work poorly for leading stocks.) Yet when a market gets EXTREMELY overbought, instead of signifying a market that's in need of a pullback, it's actually telling you there's a sudden, dramatic, powerful change in perception among investors...and such a change usually persists for months.
These "super-overbought" readings have historically occurred near the start of major bull markets (hence the blast-off moniker). Instead of pulling back following these signals, the market either consolidated briefly, or simply pushed higher...and did so for many months! Thus, while blast-off indicators are rarely of use, when they do turn bullish, they are VERY useful.
One blast-off indicator I follow is the A-D Line ratio; specifically if on average twice as many stocks advance as decline on the NYSE over a 10-day period, you've witnessed a rare surge of buying power. The blast-off indicator gave a buy signal in late March, and soon after in Cabot Market Letter I wrote that "overall, following these signals, the S&P 500 was up more than 7% three months later, and up more than 15% six months later. More important is that many of these dates kicked off sustainable new bull markets that lasted more than a year--other pinpoint buy signals came in January 1987 before a huge run, August 1982, as the mega-bull market began, and January 1975, marking the end of the 1973-1974 bear."
Since late March, of course, the market has headed straight up, despite a bunch of "we've come too far, too fast" calls from pundits.
Last week, we might have received another rare blast-off signal. (I'll explain the "might" part of it in a moment.) This one tracks the percent of all NYSE stocks that are trading above their 10-week moving average. Again, when the readings get up to 70% or 80%, the market is usually ready for a pullback.
But when the readings get up to 90%—that is, nine out of 10 stocks on the NYSE are trading above their respective 10-week moving averages—it signifies a kick-off of major proportions. On average, the S&P 500 was up about 15% six months after these signals. Most impressively, during the next nine months, corrections in the index have been limited to 5% in general. So not only were there hefty gains, but the ride was relatively smooth.
The only hitch with the "90%" indicator is that different data sources are giving us slightly different readings. One trusted source tells us the figure hit 92% last week; another source, which has been around for decades, said the reading only got to 88%. So we can't say for absolute certain if we got there, but it sure looks like it.
Now, in terms of the current market, I did see some signs of institutional selling last week. A couple of times the market opened higher on good news, only to fade as the day wore on. And the Nasdaq Composite is bumping up into its downtrending 200-day moving average, a natural place for some investors to take chips off the table. Thus, I wouldn't be surprised if we're finally going to get more than a two-day pullback...possibly much more.
But longer-term, these blast-off indicators tell you that the odds are strongly in favor of higher prices in the months ahead. So look to buy on weakness, be it individual stocks, or even exchange-traded funds (ETFs).
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