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OPINION

Bullish developments

Bullish developments
November 7, 2013
Bullish developments

 

Dow indices surge

In the words of Jack and Bart Schannep of thedowtheory.com, the most accurate experts on the interplay of these three indices, their latest move has put them "in the clear." From mid-September to early October, they were at risk of switching into a downtrend. Their latest break to new highs has put that particular danger to bed, at least for now.

 

Bad breadth before

Not only has the price uptrend in the world's most important stock market been confirmed, but its internal make-up has improved too. I noted some weeks ago that breadth on the New York Stock Exchange had worsened noticeably over the previous four months (Bad Breadth, 26 September) and how this was a worry for the bull market’s medium-term survival.

Breadth is the concept that says that a healthy trend in an index is one in which most of the index members are taking part. So, when the FTSE 100 is going up for example, we would want to see as many of its individual members as possible consistently doing the same. When the index as a whole is going one way but a majority of its members aren’t doing the same, it can be a sign of internal weakness.

 

Bad breadth cured

In recent weeks, the advance-decline line - my preferred gauge of breadth, discussed here (http://bit.ly/1iMnbVd) has triumphantly reversed the downtrend that it had been in since May. The AD line lately hit a fresh all-time high, along with the indices.

That price and breadth are now confirming one another again is a relief. It does not guarantee that the market won't make an imminent top, but it makes it less much likely. Between 1929 and 2007, four fifths of stock-market peaks were hailed by a weakening AD line. The AD line tended to trail off by an average of 279 days in advance.

It could be that the present bull market proves to be one of the exceptions, where price and breadth climax together or where breadth tops after price. That is what happened in 2011, for the first time in some 35 years. For previous examples, you have to go back to the 1930s and 1940s. But probability favours us bulls on this one, I think.

Breadth does not claim to be a market timing device, of course. And the message from a genuine timing gauge is somewhat less favourable. I saw this week a warning from Richard Mogey (cmffinvestments.com), the world’s leading expert on cycles in financial markets, that two important long-term cycles are due to roll over before long. The activity of the 24- and 40-month cycles, he says, imply economic weakness ahead and a larger correction.

 

Peaking cycles

Some of Richard’s previous cycle projections have been uncannily accurate, such as in early 2010. Back then, important cycle-peaks coincided with the end of the first round of quantitative easing and Wall Street suffered a near-bear market. Should the withdrawal of QE begin sooner rather than later, I would not be surprised if we saw something similar within the suggested timeframe. Meanwhile, I would echo Richard's advice: remain long but cautious, very cautious.