Analysts and market commentators have spent much of 2018 majoring on an array of potential obstacles for the nine-year-old equities bull market. From the Federal Reserve supposedly tightening monetary policy to the potential threat from trade tariffs, investors have been given a list of things to worry about. But what these observers have missed is what’s right about this market. And what’s right about this market is an increasingly strong internal profile as we’ll examine in this report.
With summer fast approaching, the broad market outlook is looking better now than it has all year. In just the last couple of weeks, one of the biggest problems plaguing the U.S. stock market - namely a surfeit of stocks making new 52-week lows due to higher interest rates - has diminished considerably. The pullback in Treasury bond yields last month lifted a heavy burden from the stock market by giving rate-sensitive securities a breather from the near-constant internal selling pressure in February-May.
One of the best ways of measuring the overall strength or weakness of the broad stock market is to look at what the old-timers on Wall Street used to call the “tape.” Today the tape can be evaluated by simply looking at two basic elements of the market’s performance: breadth and volume. There are three basic measures of breadth and volume. The first is the advance-decline (A-D) line, which measures how many stocks are rising versus falling on both major exchanges. The other is advance-decline volume, which shows whether the volume of trading is rising or falling on a cumulative basis. And the third is the new 52-week highs and lows, which measures incremental demand for equities. Taken together, these three indicators will show just how healthy the stock market really is below the surface and also how much internal momentum is present. The greater the momentum of the A-D line and the new highs-new lows, for instance, the more likely stock prices are to rise in the foreseeable future.
The old-timers on Wall Street also had a saying which you’re probably familiar with, namely “Don’t fight the tape.” In other words, when the tape is reflecting strength below the market’s surface don’t be foolish by selling short a strengthening market. “The trend is your friend” would be another way of expressing this sentiment. With that said, let’s take a look under the market’s hood and see just how strong the tape really is right now.
The NYSE advance-decline (A-D) line is as strong now as it has been in months. You can see the impressive rising trend in the cumulative A-D line below. What’s even more impressive about the A-D line is that it was trending higher even earlier this spring when the major averages were still stuck in neutral trading ranges. This shows that buying interest among informed investors was always quite high throughout the last few months even when the market appeared to be weakening due to rising Treasury bond yields. A rising A-D line is a strong confirmation that the stock market’s overall trajectory is likely to remain bullish in the foreseeable future.
Another aspect of how strong this market is as we head into summer is the NYSE cumulative volume line. Advance-decline volume on the NYSE is essentially in sync with the A-D line shown above. This tells us that the strength of the buyers has been formidable and broadly based. If the market was rising while cumulative volume was declining, it would actually serve as a “heads-up” warning that the strength of the buying was diminishing. Clearly, that’s not the case right now.
Last but certainly not least, the new 52-week highs and lows have been nothing short of stellar this month. Not only has the number of stocks making new lows diminished recently, which is a sign that internal selling pressure isn’t a problem, but the ratio of new highs-to-new lows has steadily increased since last month and has been averaging around 4:1 on the NYSE and around 6:1 on the Nasdaq. That’s about as strong as one can expect in a market controlled by the bulls.
Moreover, the momentum of the new highs and lows has been accelerating. Shown here is the graph of the daily cumulative new highs-lows for the NYSE. The chart speaks for itself and the trend of the highs-lows has gone nearly vertical in the last two weeks. That’s arguably the single best indication that the demand for stocks is growing and will supplant any shortcomings created by the short-term “noise” created by the latest headlines. No matter what sort of news gets thrown at this market, the tape tells us to ignore it and assume that the upward march of the major averages will continue this summer. The most important takeaway from this review is that we must resist the temptation to fight the tape.
In light of the market’s strong condition, I continue to recommend that active investors maintain a firmly bullish stance and optimistic attitude toward equities. Selective purchases among the stocks showing definite signs of relative strength are warranted, including leading tech sector, retail, and transportation sector stocks as discussed in recent commentaries. In particular, investors should continue to focus their attention on the tech sector.
Disclosure: I am/we are long XLK, HACK, IYR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.