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S&P Cumulative Advance Decline: Positive Divergence




The last time we checked in on the cumulative advance decline line for the S&P 500 index, it was at a high. It managed to inch a little higher in the days that followed but unlike my expectations, it didn't top out ahead of the index. Instead it peaked and has dropped concomitantly with the market. In fact, the top in the cumulative AD line corresponds to the S&P 500's own top on April 23rd, 2010 at 1217.28 points.

Since then it has fallen along with the market, as you can see in the chart below, with one important difference. While the S&P 500 index itself has fallen to the levels we last saw a few months ago in February, the cumulative advance decline line is continue to hover significantly higher than where it was back then.

Click to see larger version of charts in new tab:
S&P 500 and cumulative AD positive divergence Jun 2010
S&P 500 cumulative advance decline positive divergence Jun 2010

The S&P 500's cumulative advance decline line was at 9248 on February 8th 2010 (the end of the correction). And during last week, it fell to a low of 11532 on June 1st 2010. So 2284 cumulative AD points separate the two dates. That is a significant degree; about 25% higher. Meanwhile, on the chart of the S&P 500 index, there is almost no difference since that index is basically where it was at the bottom of the February correction.

This important divergence tells us that market internals are telegraphing a hidden strength in the S&P 500. While based on points it is back to where it was 4 months ago, based on cumulative advance decline parameters, it is continuing to make higher highs (assuming the cumulative AD line recovers of course).

A Bullish Grey Beard
I keep track of several stock market gurus, or as I call them "grey beards". The list is short, Warren Buffett, George Soros, Jim Rogers, David Rosenberg, etc.. These men have first hand experience of several market cycles as well as being serious students of the market. Of these, several like Steve Leuthold, literally do have grey beards. Right now, the head of the eponymous Leuthold Group LLC is staunchly bullish telling clients in a May 20th 2010 report to treat the weakness since April 23rd as a buying opportunity.

Doug Ramsey, Director of Research for the firm said in a recent interview: "There’s no way the European debt problems are going to be enough to derail the growth that's taking place in our economy and in Asia." He estimates the S&P 500 to climb at least 19% by year end.

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9 Responses to “S&P Cumulative Advance Decline: Positive Divergence”  

  1. 1 oexrex

    your observation is accurate however the a/d line made a slightly lower low today relative to the past month and the selling today seems to have picked up a bit from Friday, therefore I am going w/ the trend and until I see differently assuming that the consolidation will morph into a distribution

  2. 2 Babak

    oexrex, you're right, it did dip to a new swing low as a result of the weakness today but the positive divergence still stands as I pointed out above. For that to be neutralized, the AD line would have to fall more than 2100 points from here.

  3. 3 JAC

    Babak,

    Can it also mean, the correction hasn't run it course. It has to be more oversold so they converge?

    My point is it depends on the assumption you are making, if this is a minor or major correction. If it is a minor correction, divergence is the way to look at it and if it a major correction, that means there are still people hiding and they have to sell for this correction to end. Is that right?

  4. 4 Babak

    JAC, they don't "have" to converge, that's what makes the interpretation of the current AD line so bullish. The SPX is capitalization weighted while the cumulative AD line isn't so what that means is that while the large caps stocks are getting clobbered, most of the others are holding up very well (relatively speaking).

  5. 5 aviat72

    The cumulative A/D line is strongly affected by the number of days where the A/D is moving up versus down since the absolute value of a single day can not be more than 500.

    The April high was preceded by almost three months of continuously rising prices which drove the cumulative A/D to lofty highs. The Jan highs followed about three months of range bound consolidating action during Q409. As a result the cumulative A/D ran up much higher in April than it it did in Jan.

    That is why in spite of a much larger fall in the SPX the cumulative A/D is still higher. It is just a confirmation of the fact that markets tend to fall much quicker than they go up. Perhaps would you need to consider is the average daily A/D as measured from the high pivots. Very likely that the average decline during this period is higher than the Jan-Feb correction.

    Last week the UpVolume/DownVolume ratio was close to 120; unheard off even during the great crash

  6. 6 Babak

    aviat72, the cum. S&P 500 AD line has fallen 22% from its recent high (so far). In comparison, it fell 17% in February.

  7. 7 Sumeet

    aviat72, did you mean to say the reverse - downvolume vs upvolume was 120?
    I think thats another sign that everyone has rushed to exits last Friday.

    Also, regarding your observation about April high preceded by huge momentum in lot of stocks (leading to high cumulative A/D), that is precisely the point.
    Generally speaking, markets dont top out suddenly. Some stocks / sectors start topping out and eventually most of the market is topped out.
    The chart above tells me (assuming A/D line will recover) that we would have substantial number of stocks not having topped out.
    Even if A/D line doesnt recover (and S&P recovers to a new high), it means some stocks have topped out in April. And we need to be more picky in stocks going forward - but not the end of bull yet.

    My 2 cents...

  8. 8 jezza

    Babak, very interesting insight on A/D..many thanks.

    Also options sentiment is very negative, one sided at present, which may (?) give a contrarian signal.

  9. 9 aviat72

    Sumeet:

    Yes I meant downside volume.

    Markets can also have a V shaped top. There was a guest article which Babak had posted which talked about that, especially in the context of cyclical rallies in secular bears.

    You can look at each trade in two ways: New business being initiated vs. Old Business being closed.

    Whenever you have old business being closed, there is a much bigger sense of urgency to close the trade. New business has the luxury to ponder and wait.

    In a typical bull market correction, you will often see V shaped bottoms since the shorts do not have too much conviction and once a degree of pullback is reached, start covering especially at the first sighting of serious buyers.

    Similarly in a cyclical bull within a secular bear, the longs start becoming uneasy as the market continues to rally, and when it comes for the time to pull the plug will do it quickly, resulting in a V (inverted) top. This is especially so in the current run since shorts have been decimated and the urgency to close old business and provide buying support was lacking.

    Most of the price-action in equities has been driven by government intervention for more than two years. With the financials and energy under scrutiny in Washington, and the foreign earnings of tech under pressure due to the rising dollar, the stock market currently lacks leadership. Consumer discretionary can provide leadership for so long, especially when Leading Economic Indicators, ECRI etc are all pointing towards lower growth rates.

    What might trigger another leg of the bull in the short term is strong equity-friendly government intervention in the form of a new stimulus in the US, more decisive and larger QE in Europe. Otherwise the market will have to wait for the earnings season to provide a new catalyst.

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