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One of the reasons why market technicians believe that we are still in a primary uptrend is the incredibly strong advance decline lines for major indexes. The NYSE advance decline is the most common but I refuse to consider it an accurate measure of the stock market. Unfortunately, it has become too warped by the inclusion of non-operating company securities. Most of these are interest rate sensitive issues so they move in tandem with the bond market, not the stock market. This is why the NYSE breadth can mislead you and why I refuse to use it.
There are several ways around this. One is to look at the NYSE operating company only advance decline line. This is a bit hard to find because of the work involved but usually top notch firms like Lowry Research and Ned Davis Research have it. The other, more simpler way is to sidestep the whole issue by looking at the advance decline line of an index which is composed of operating companies. For example, the cumulative advance decline line for the S&P 500 index.
This breadth measure is critical because it is telling us that as the S&P 500 index rises, it does so powered by a majority of its constituents. This is not a case where a few stocks are receiving the bulk of buy orders and dragging the index up grudgingly (like we saw in the later stages of the tech bubble in 2000). As well, if you caught the recent interview with Richard Dickson of Lowry Research, he mentioned that we are seeing the advance decline lines for major indexes lead the market higher.
You can clearly see that this is the case with the S&P 500 index advance decline line. It took the S&P 500 index itself until March 16th 2010 to decisively break above its January 2010 highs. But the cumulative advance decline line for the index surpassed its January high much earlier, on February 19th, 2010. But it has yet to surpass its previous high set on October 12th 2007.
Also, note that it set an earlier peak at 13592 on July 12th, 2007. And that if we step back, from early 2007 until early 2008, the cumulative advance decline for the S&P 500 index basically meandered sideways, unable to make headway in a concomitant uptrend with the index that it is suppose to track. Here’s a longer term chart for the S&P 500 index advance decline line going back to 2003:
Usually advance decline lines will top out and start to decline ahead of major market indexes. Clearly we are seeing the exact opposite of that right now. The other market internal metric which is critical is the number of new highs. As long as we have the market showing a significant number of new highs, the bull market is intact. Historically, the number of new highs peaks ahead of the market by a year or so. Right now, we are seeing the number of new highs (or their relative number) hit new highs itself. So again, we are seeing the opposite of we would see at a major top.
Having said that, I am very cautious in the short term. While I do believe that we are still in a primary uptrend, based on these breadth metrics (as well as Wayne’s excellent recent post on tape reading) it is important to be cognizant of the short term clouds forming over the horizon.
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