The Nature of Market Tops, Part 2

The Nature of Market Tops, Part 2

Going back to June, 2015, in truth the markets had been weakening long before June. In August 2014 (almost a year earlier), the adv/dec line had made a double top (stopped making new highs) but the momentum indicators (momentum is a leading indicator) were showing serious weakness. Both intermediate and long term momentum had put in much lower tops on the second top made by the adv/dec line in late August. The market was preparing itself for its October swoon in 2014. After the market sold off in October, it put in a v shaped bottom and shot right back up again. But the ensuing market that followed was a different market. Sure the indexes that everybody watches were making new highs. But the underlying market was much weaker. Long term mom barely inched up past the lows made in October and looked anemic. Intermediate term momentum was capped at the 50 percent level after pushing the 100 percent level the previous summer. The distribution top carried on through the winter and spring of 2015. Risk was at a elevated level at this time with little reward in the offing. I saw all of this and turned a blind eye to it. I didn’t want to believe it so I stopped looking at it. Such is the importance of psychology when investing in the markets.

Permit me a few observations...

I don't trust indexes like the SP500 and the Dow Industrials.  I feel they can be too easily manipulated and yet they are the indexes the mindless media focus on or maybe the indexes they are told to focus on...who knows.

The adv dec line of the NYSE is of pivotal importance. It shows how the whole market of the NYSE is performing. By applying a few simple moving averages to it and generating some momentum indicators from those moving averages you can gain genuine insight into the state and health of the stock market.

The temptation is to try to predict the future of the market from these indicators. I feel that is a mistake. Ive already droned on about the fallacy of trying to predict the market (the ego, remember). I see it as a risk management tool. Something to help you weigh the risk reward condition of the current market place.

The object of applying moving averages to the advance decline line and generating momentum indicators from those moving averages is to filter out the noise of the market. This will leave you with the meaningful messages and signals of the underlying data. Pay attention to the signals, not the noise.

The Nature of Market Tops

The Nature of Market Tops

The markets have been going up for a long time and everybody has forgotten about the Lucky Idiot’s gun with its ten thousand chambers. You remember; that’s the gun that had ten of those chambers filled with bullets. But everything has been so good for so long everybody has forgotten about that. The indexes have been constantly pushing higher. The media is leading the parade cheering each new high in the indexes with firecrackers bursting and banners flying. Investors are out in the streets doing cartwheels or at least it just feels that way. But underneath the indexes, the market, the real market is giving way. The adv/dec line of the NYSE is slowly deteriorating. Its 39 day moving average is flattening out and turning down to the extent that the adv/dec line is now spending more of its time below that moving average. It might be mid June, 2015. After awhile the 39 day ma will move below the 144 day ma which in turn is slowly rolling over and headed down. The underlying market is unmistakably getting weaker, much weaker. It’s now early August, 2015. You know how this story ends.

The lords of the playing field (informed money) have been slowly distributing (selling) their shares out to the great unwashed (everybody else). Everybody who can buy has already bought and there is no way to go but eventually down. When the music stops the chairs will be full with no place to sit.

It’s been my experience to ignore the market indexes. Everybody follows them. There is no Wager Value in looking at them. Instead keep a close eye on the adv/dec line of the NYSE (based on common stocks only). You can get this information summarized neatly for you in the weekend edition of Barron’s. The adv/dec line along with its assorted moving averages and momentum indicators has Wager Value in that few people pay attention to it.

The Hidden Message in the Stock Market Revisited, Part Three

The Hidden Message in the Stock Market Revisited, Part Three                                 

So what’s happening now on this day of Tuesday, April 19 2016. Longer term mom is way above its signal line. Intermed term is way above its zero line and is overbought. Short term oscillator is making a lower top. The market has had an extremely strong move up from its bottom. So in the short term (next few weeks) it is due for some type of pullback. But in the longer term which is the neighborhood I hang out in, things look fine. When the market experiences such a strong impulse wave up from a bottom it is usually a harbinger of better times ahead. This is the backdrop for the current market environment. There still seems to be a fair amount of bearishness out there which is good. Bull markets climb a wall of worry. If you are a long term holder of stocks, stay the course and tune the media out. 

To recap the four things I look at to evaluate the state of the current market environment are...

  

the advance decline line with it's 39 and 144 day ma (only the direction is of this data set is important.) 

the long term momentum of the a/d line (both the direction and level of this indicator are equally important.)

 

the intermediate term momentum of the a/d line (both the direction and level of this indicator are equally important.)

the short term oscillator of the 10 day ma daily a/d differential.

Incidentally, you can use chart patterns and trend lines on the intermed term mom which I have found interesting in the past. If you don't want to bother with any of this good stuff, keep an eye on the MClellan Summation Index (another version of intermed mom) which you can find here...and remember nothing ever really bad happens when the summation index is above zero...

http://stockcharts.com/h-sc/ui?s=$NYA&p=D&yr=3&mn=0&dy=0&id=p83733137120

The Hidden Message in the Stock Market Revisited, Part Two

The Hidden Message in the Stock Market Revisited, Part Two                                   

In lieu of my last post, permit me some observations…

Keep in mind that everything I talked about in my last post was after the fact, while it is true that I did notice the things I mentioned I was still looking out into an unknowable future where anything could have happened. When using this data about the adv/dec line and its momentum indicators there will be a strong urge to predict and forecast future market movements. I strongly suggest you resist that urge. Remember when you try to predict the future you will be facing two formidable antagonists, your Ego (yourself) and randomness (pure chance). Instead I think you will be better served by using this information to manage your risk. If the market is going up but losing momentum along the way, you may want to trim some of your overbought positions (it would be nice if they didn’t pay out a rising dividend) while putting some cash aside for future opportunities. When the market is bottoming and momentum is indicating that divergences are taking place you can take on some oversold positions with a “margin of safety”. Don’t forget to thank “Mr. Market” for the opportunity. And keep in mind these decisions will be few and far between, the market doesn't always have something to say.

Try to look out at the future as a series of outcome scenarios . Howard Marks has written about this and called them probability distributions. In other words various outcomes are possible and at different amplitudes. Basing your judgements on the current market environment ask yourself what are the chances of such and such occurring. This strikes me as a better way to utilize the information that the adv/dec line offers. 

One more thing, if you do notice the market is topping out or bottoming, pay attention to the sectors in the market. Oil topped out with the market in the late summer of 2014. And the material sector started their rebound off the the market lows of January this year. The market is an interesting place.

The Hidden Message in the Stock Market Revisited

The Hidden Message in the Stock Market Revisited                                   

Its alright Ma, I’m only taking a beating

with apologies to Bob Dylan

During late August of 2014 a disturbing trend was developing in the advance decline line of the NYSE. After going straight up since December of 2012 it seemed to be topping out. After making a new high in July it sold off and made another high in late August but it was slightly lower this second time. The momentum of the adv/dec line was saying more. Long term momentum was down sharply on the second high in late August. Intermediate momentum put in a much lower top. I was worried. I haphazardly sold off some positions. Selling is always hard. But in September I jumped back into the market and bought some pharma and financial stocks because I wanted more exposure to that part of the market. It was done on impulse. I spent years developing these momentum indicators but because the market had been so strong for so long I never paid too much attention to them.

Anyway the market went down sharply that October, put in a V-bottom and bounced straight up. Over the ensuing months it continued to go up but once again my charts of the adv/dec line and the charts of its momentum was telling a different story. The 39 day moving average of the adv/dec line was much closer to its 144 day moving average. The market was clearly losing momentum. Long term mom was trending slightly higher but at a much lower level than where it was that previous summer. Intermediate term mom was capped at the 50 percent level after being much higher in the summer. This continued on during the spring and summer of 2015. What did I do? I stopped looking at my indicators. I didn’t want to believe what was happening. Some of my best performing stocks were way up above their long term moving averages but I couldn’t get myself to sell them. All of this was going to prove to be a very painful lesson. Momentum really started to break down in June that summer. Intermediate term mom broke below the zero line. The market was screaming at me to do something, but I couldn’t rouse myself to act. I would generate my charts on the weekend but didn’t want to look at them. In early August long term mom went below the zero line.

The market caved in around August 20th and bounced back in October at extremely low momentum levels. I felt trapped but hung on. The market sold off again in November and December, it felt like chinese water torture. Momentum continued to deteriorate topping out at lower and lower levels. In Jan of this year it caved in again. When you go through something like this you stop looking at the market because it is just too painful. It was too late to sell.

Momentum bottomed in late January 2016. When the SP500 tested that bottom in mid Feb intermed mom and the short term oscillator were both higher. Long term mom was headed up after putting in its lowest bottom since 2011. I felt a prominent bottom was in place. I didn't know how high this bounce in the market would be but I did feel that an important bottom had been put in. Market sentiment was awful. The media was doing their part painting as dark a picture as they could but I knew better.

The move off the bottom has been so powerful that it is a message in and of itself. Impulse "up waves" occur when a market is oversold and then surges up from nowhere. I read about this from Justin Mamis in his book, The Nature of Risk. I'll have more to say about all of this in my next post.