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Impending Stock Market Upside Surprise, Part 1: Incredible Strength

|Includes:SPY, Vanguard Extended Market Index ETF (VXF)

            Evidence abounds that the current stock market advance will intensify by the end of the year.  A key element is the incredible strength of the present uptrend in market prices. At the close of an CNBC interview last week, Laszlo Birinyi, who is bullish on stocks at the moment, noted that almost everything was going up, while he instead preferred a stock-picker's market in which quality research and ability are rewarded.  Indeed, the modest daily advances in the most closely watched market indices have masked a more overwhelming move by the broad market recently, and the strength has continued to increase.  In this market almost everyone is a winner, to the chagrin of the pros like Mr. Birinyi and the regret of bearish skeptics who watch from the sidelines.  The availability of considerable cash and the market strength and breadth support a strong move to higher prices.


A New Milestone: Advances/Declines


            By the close on Friday, yet another significant milestone was reached, when my measure of the 10-day advance/decline ratio [A/D] markedly exceeded a value of 2.  This was cited long ago by Martin Zweig [Winning on Wall Street] as a precursor to significant up moves in the market.  For convenience, I derived the following definition of a 10-day A/D value, which uses readily accessible weekly data on the NYSE and the NASDAQ:


A10/D10 = [A1 + A2]/[D1 + D2],                                                                       (1)


where A1 is the sum of the number of advancing stocks on the NYSE and that of the NASDAQ after the first week (subscript "1") and the remaining quantities are defined similarly for advancing and declining (subscript "D1") stocks after the first week and after the following week (subscript "2"). This rather naive formula is exact if one estimates |dPw[i]|, the magnitude of the weekly change in price of each stock (indexed by i), in terms of <dPw>, the average weekly change in prices of all stocks for the two successive weeks considered:


|dPw[i]| ~ 2 <dPw> [A1+D1 + A2 + D2]/[A1 – D1 + A2 – D2].             (2)


Equation (2) also assumes the almost trivial condition that the weekly advances and declines of the combined set of stocks traded on the NYSE and NASDAQ are not balanced over the two-week period (denominator nonzero) and ignores the stocks which do not change in price over a given week. With this estimator of the magnitude of the weekly change in the price of each stock, the approximate change in the combined market capitalization over the two-week period is proportional to the total number of weekly advances minus the total number of weekly declines. Equation (1) follows directly.


            A value of A10/D10 > 2 is highly unusual and significant. Using weekly data provided by the Wall Street Journal Market Data Center [], I find that A10/D10 > 3 for the most recent two weeks.  According to Martin Zweig's research in Winning on Wall Street, this strong reading bodes well for higher stock prices over the next several months.


Percentage of Stocks Above Their 50- and 200-Day Moving Averages


            The percentages of stocks above their 50- and 200- day moving averages (which I will call P50 and P200) are also currently at extremely high readings (well above 80%). This again indicates tremendous strength across the broad market, with the indicators having risen meteorically from values near 10% in early March.  Surprisingly, this aspect of P50 and P200 is often ignored. On an episode of Wall Street Week which I remember vividly, Robert Farrell, a famous stock market analyst for several decades until retirement in 1992, publicized P200 as his favorite indicator of market extremes. Today, the standard expectation of extreme readings in P50 and P200 is that a market reversal is in the offing.  Nevertheless, the current values of P50 and P200 show that an unusually strong and broad market move is ongoing.


            The above indicators and similar measures show massive, broad strength in the stock market, and when combined with catalysts provided by economic indicators, interest rates, and the position of the Federal Reserve, portend a strong market advance over the next several months. The upcoming Part 2 of this discussion will detail the catalysts for such a move, including the cash waiting on the sidelines and the frustrated holders of that cash.


The author currently holds investments in an index fund that is equivalent to VXF and SPY.
Stocks: VXF, SPY