Opinion: Bull market revival or false leader? These five indicators will give the green light to a sustained rise in stock prices
The first trading day of 2022 was promising for the stock market: the benchmark S&P 500 index hit a new all-time high.
It’s been downhill ever since.
The March and May rallies failed and were followed by lower lows, a bad sign. It took until June for the index’s cumulative decline to exceed 20%, earning a “bear market” label.
But such thresholds are arbitrary and may add more confusion than clarity. Beneath the surface, there has been downward pressure on stocks dating back to 2021.
Stocks are now preparing for their longest attempt at a rally since their January high. The March rally was more intense – 11% versus the current 8% – but lasted just 11 trading days versus more than 20 days since the mid-June lows. This raises expectations that a sustainable move higher could emerge. Perhaps a new bull market is already emerging.
Skeptics warn that some of the most intense rallies occur in bear markets. March’s experience – four consecutive gains of 1% or more on the S&P 500 – echoes this. Just looking at the magnitude of price movements can make it difficult to distinguish between signs of lasting strength and evidence of a volatile market. In March, it turned out to be more of the latter.
The increase in volume to the upside reinforces the idea that a sustainable move up could be in the works. This is particularly positive now as he was notably absent in March.
On Friday, July 15, “up” volume exceeded “down” volume on the New York Stock Exchange by better than 9 to 1. Two trading days later – July 19 – up volume exceeded the volume down more than 14 to 1.
The March rally didn’t even produce a single day of 9 to 1 upside. We had a single 9 to 1 day in May, but several days of 9 to 1 downs soon followed.
History suggests that seeing two days of higher volume above 9 to 1 with no intermediate down day is an indication that the market’s downward momentum has been broken. To start going up, the market must first stop going down.
While this is an encouraging step in a positive direction, it does not provide a clear signal. An upward surge in volume is just one of five indicators in the checklist – posted above – that we relied on to facilitate an unemotional distinction between volatility and strength. It tends to be the first to improve, but may also be the most likely to reverse – a few days of heavy selling can reintroduce bearish momentum.
Sustained upward movement is unlikely as long as conditions below the surface remain difficult. Although the new low list is shorter than in recent weeks and months, it is still longer than the new high list.
On a weekly basis, new 52-week lows in the NYSE and Nasdaq have outnumbered new highs for 34 consecutive weeks – the longest stretch since the financial crisis nearly 14 years ago. Even though the upside volume surged and prices rallied, we continued to see more new lows than new highs on a daily basis.
The 74 straight days of more new lows than new highs on the Nasdaq is the longest streak in more than two decades. Our new net up/down line (which measures the cumulative number of new highs minus new lows on the NYSE and Nasdaq) has been trending lower since November.
While some may view them as wants rather than needs or expect improvement later, the reality is that all net gains in the S&P 500 SPX,
Nasdaq Composite COMP,
and Russell 2000 RUT,
over the past 20+ years, more stocks have made new highs than new lows.
Our risk indicator looks at the relative price performance between asset pairs within and between asset classes. It objectively measures risk appetite. Since the beginning of this year, it has decisively signaled a risky environment.
While a shorter-term version of this indicator peaked in risky territory, the strength was never persistent enough for the longer-term version to cross the threshold. A sustained recovery is likely to produce a healthy appetite for risk that is evident across the board.
The most durable indicators on our checklist could be new 20-day highs on the S&P 500 above 55%. (This indicator has been attributed to Jeff deGraaf.) This produces a surge of magnitude that creates a favorable regime lasting for a year. This indicator has signaled spikes in magnitude on 26 occasions since 1976. In just one instance did the stock decline a year later, and market returns during those regimes were double the average over all time periods.
We don’t have the gift of foresight and we don’t know what the future holds. But we have evidence from the past to help inform our current conclusions. The world is a dynamic place, and we must be ready to adapt.
As Keynes once wrote, “when my information changes, I alter my conclusions.” As the evidence indicates that a more favorable environment has emerged and a new bull market is underway, we will look into it. We took a step in this direction last week, but there is still work to be done.
Willie Delwiche is an investment strategist at All Star Charts, where he runs the ASC+Plus service designed for finance professionals. Follow him on Twitter.