Bull Market Not to be Underestimated

The bulls capped off a big week on Friday as the NASDAQ gained 1.4% for the session, and nearly 4% for the week. Volume was well above recent average levels so clearly there were convicted buyers pushing up prices last week. This is exactly what we want to see on a big up-week.

This is not the type of bull market you want to just blindly jump out and short. That is a great strategy to lose money, because remember one of the most important rules for trend trading, stay in tune with the markets, and be positioned in the direction of the primary trend, not against it.

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The bulls capped off a big week on Friday as the NASDAQ gained 1.4% for the session, and nearly 4% for the week. Volume was well above recent average levels so clearly there were convicted buyers pushing up prices last week. This is exactly what we want to see on a big up-week. Strong buying support, prices closing near highs, and lots of stocks breaking out.

There are turning points, few and far between, where a contrarian strategy is a great way to make money. But most contrarians lose sight of the fact that there is a substantial difference between having a contrarian mindset, and the successful implementation of a trading strategy based on that thesis. I could go into a variety of fundamental arguments about why this bull market is a sham, and also give an equally convincing pitch about why this is the best time to buy stocks in years. The reality is that none of this helps YOU make money, which is quite frankly a principle reason why people invest, trade, and read this site.

Technical market analysis is the most logical, objective approach to executing a sounds investment thesis. There is no debate about the most recent closing price on the S&P 500 or the slope of a 50 day moving average trendline. However, we could easily sit here all day and debate PE multiples and incremental cash flow valuations. In the end could we walk away with a confident assessment of the stock markets' action? Highly unlikely in my opinion. Thus Technical Analysis is a study that all investors should embrace, even those that ground their investment decisions on fundamental analysis. Timing is a critical aspect to reaping a profitable investment, and technical analysis is the best method for executing a fundamental strategy.

It is critical that we stay perfectly cognizant of our psychological weaknesses, because we are constantly bombarded with information that works to break down our mental defenses. As an investor, outside information is important to making investment decisions, but it can also be our greatest enemy. As I am sure many of you know, sentiment is usually most bullish near a market peak, and most bearish near the bottom. The news-flow and talking heads break down our objectivity at the exact moment when being clear-headed is most critical, but if we can anticipate this and remain acutely aware of this simple fact, the likelihood of being caught off guard can be minimized. This is a technique that would add measurable value to all investors and traders over time that are willing to invest in improving their own mental processes.

So how can we apply these principles right now. The answer is simple, tune out the noise, the employment numbers, the bank failures, and focus on what the market is telling you, not the media. The media doesn't determine whether or not an investment is profitable, whether the price moves with or against you, it is the market that does this. Lets take a look at what the market told us last week:

The S&P 500 rose 3.1% on lighter volume, the NASDAQ nearly 4% on much heavier volume. Lets take a moment and dig a bit deeper here. We know the NASDAQ has been leading the way to the upside this entire bull market, and we have said many times on this site that this was the best area to look for alpha. The fact that the NASDAQ led the way higher last week, and did so on heavier volume tells us that the long term trend is still healthy. It is a red flag when market action diverges from what we have grown accustomed to, but what we are seeing now is status-quo. Tech. is strong and has been for many months, and studies show that strong stocks are more likely to strengthen 6-12 months out, not weaken.

Nothing more then a casual glance at our technical indicators confirms that this bull market is still rolling. Despite a small, and unresolved, short-term bearish divergence on the weekly RSI, all other signs confirm the move.

 

 

 

Looking at the equity index charts, we can see a clear upward 12-month trend from "March to March". A powerful move has been set in motion, and it is highly unlikely that it will reverse in an instant. Strong market trends slowly weaken and typically flash major warning signs before they reverse and cause major damage. The big money is made by those who recognize this, and are patient enough to stick with their positions until the market, and nothing else, tells them it is time to get out.

Moving on to our intermediate term cycle outlook, it still appears as though a substantial move could occur later this month. It could be an intermediate high, a major breakout, or a low, it is difficult to determine at this point. What we do know is clear though, tread carefully around those upcoming few days and when the picture is clear, strike without hesitation.

 

 

 

We typically offer a brief Dow Theory outlook as well in these weekly posts because it is a time-tested method of determining the market's primary trend, and to identify key long-term trend reversals.

The picture remains quite bullish as we can see on the chart below. The sequence of higher peaks and higher troughs remains unbroken, and their are no major price divergences between the Dow Jones Average and the Dow Transports.

 

 

So at this point we have mapped out a pretty good assessment of the long-term stock market outlook. But now we will peel off one more layer and see what is going on underneath the surface by examining one of our Market Internals charts.

On the NYSE Advance-Decline issues chart below, we can see a clear picture of the underlying strength of the market during this intermediate correction. The NYAD line is a cumulative index that looks at the number of stocks that are declining vs. the number of stocks that are advancing. We can use this to identify situations where equity index prices may not be telling the whole story. For example, the market indices can be hitting new highs, while a relatively low number of stocks are actually advancing in price compared to the amount of stocks that are declining. A rising equity market, with a diverging NYAD line (mid-2007) is a major warning sign. The market averages may be supported by a small number of large cap, higher priced issues, that may be exerting undue influence on the index, and make the overall outlook appear better then it actually is.

As we can see today however, the NYAD line is showing major strength and has broken to new highs in advance of prices. This is extremely bullish, and suggests that although the general market averages have been virtually unchanged for months, a large number of stocks continue to advance in price.

 

 

I know it may be incredibly difficult to ignore the fundamental arguments that speak contrary to these rising prices. But the fact is, the market is telling us that it wants to move higher, so you need to decide who you are going to listen to. The economists and journalists who have been consistently wrong and behind the curve for decades, or the market itself, through the application of technical analysis.

Below is a long-term monthly S&P 500 chart with a 12-month EMA. Use the slope of this line, and the positioning of prices relative to it, as a quick and easy way to evaluate the long term trend. Right now, this line is rising, and prices are above the EMA so the answer should be clear.