The One Signal That Should Give Bulls Hope...

Amber Hestla's picture

Wednesday, June 5, 2019 - 12:00am

by Amber Hestla

I spent considerable time this weekend trying to find something bullish to share with you. 

In the end, I decided to share the chart below. It tells us to expect more gains in the stock market. 

It's a chart of the New York Stock Exchange Advance-Decline (A-D) Line. You can find the A-D Line by tracking the number of stocks that close higher and lower every day, and then subtracting the number of stocks that closed lower from the number that closed higher. 

Thus, when you look at that chart, you're actually looking at the difference between the number of advancing stocks and declining stocks. When there are more advancers than decliners, the line moves higher. When the number of stocks closing down exceeds the number that closed up, the A-D Line moves lower. 


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A/D line chart

This is a breadth indicator. Each stock, in effect, gets one vote. This is different than price indexes where stocks carry different weights. For example, just three stocks (Microsoft, Apple and Amazon) account for more than 30% of the NASDAQ 100 index. Those same three stocks represent more than 11% of the S&P 500 Index. 

That's why the A-D Line is so interesting. When the NASDAQ 100 has a good day, it's potentially only reflecting the movements of a few big stocks. The A-D Line can only move up when more than half of the stocks traded that day close higher. 

In February, the A-D Line reached a new all-time high. I searched through history to find other times when the A-D Line recovered to new highs before the S&P 500 did after a 10% decline. This happened just seven times since 1960, the point where my A-D history begins. Seven times in sixty years is a rare signal. 

What This Means
It makes sense that this would be a rare event. Usually, a few market leaders drive the recovery after a market decline, and the leaders push major stock market indexes up. In the rare cases when the A-D Line leads the way -- like we're seeing right now -- most stocks moved up while the largest components of the indexes lagged the recovery. 

Of the three largest stocks in the indexes, only Microsoft (Nasdaq: MSFT) has reached new highs in the recovery. Apple (Nasdaq: AAPL) faces questions about future growth. Amazon (Nasdaq: AMZN) could see new regulations that aim to limit the company's growth. Other big names have also lagged in the recovery, several because of concerns related to new regulations. 

But most stocks have been moving higher, and we know that because the A-D Line is at new highs. Looking back at the seven times this happened in the past, the S&P 500 was higher 100% of the time. Individual results are shown below. 

A-D line historical analysis

The S&P 500 is now trading at the price level it was at in February, when the A-D Line reached new highs. Based on history, we should be seeing higher prices eight months from now. 

The Bearish Side
So, that's the good news. Now to the less bullish news. 

There could be a significant decline before we see those expected new highs. This became especially clear last week. 

Stocks sold off sharply on Friday after President Trump announced that he was "invoking emergency powers" to impose tariffs on all Mexican goods. According to The New York Times, Trump "said that he would proceed with an initial 5 percent tariff on June 10, which could hurt American consumers and some of its biggest companies, including automakers, agricultural companies and retailers." 

This news came as a surprise. In a rare display of bipartisanship, politicians from both parties were united in expressing their concerns. They issued statements. 

Traders also expressed their concerns. They issued sell orders. 

I believe the initial reason for the abrupt selloff was that Trump's tariff announcement was a complete surprise to the market. There was no speculation that this was coming. 

Some would argue that in negotiating a replacement for the North America Free Trade Agreement (NAFTA), Mexico was working to avoid sanctions like this. Now, other countries (like China), might be wondering what the benefit of a treaty is if tariffs are still on the table. 

That might not be the mainstream analysis, but I believe the increase in uncertainty is the reason for the selling pressure we saw in the past few days. 

No matter what the reason for the selling was, Friday's market action changed the technical picture of the stock market. 

The S&P 500 Index closed below its 200-day moving average (MA) and my Profit Amplifier Momentum (PAM) indicator reached a new low on the daily chart. The pattern in the chart below looks similar to the pattern that formed last October, at the beginning of the S&P's 19% decline. 

PAM chart

PAM is also bearish on the weekly chart, and if we get another weekly close in bearish territory, there is a possibility we could challenge the December low in price. 

Action To Take
This is a significant change in the technical picture of the stock market, and it represents a possible shift to a more bearish outlook. We need to be watching closely to see if the tone of the market is truly changing from bullish to bearish. I believe we will have a much clearer picture at the end of the week. 

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Amber Hestla does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.