Thursday, November 16, 2006

Doesn't This Market Have to Go Down?

Several attendees at the Las Vegas conference have asked me if we're ripe for a decline, given the "overbought" situation. My response has been that all market rises are not created equal. When a large proportion of stocks participate in a rise, the odds of continuation are much better than if the rise is dominated by just a few issues or sectors.

Let's take a current example. I track the number of stocks making fresh 65-day highs and lows and compare this number to the 100-day moving average of new highs and lows. When fresh 65-day highs greatly exceed the average number of new highs that we've seen over 100 days, that tells us that participation in a rise is solid.

Since 2004 (N = 703 trading days), when the relative new highs have exceeded 400--as at present--there has been no significant trading edge five days out. Twenty days later, however, the S&P 500 Index (SPY) has been up by an average of .94% (68 up, 23 down)--considerably stronger than the average 20-day gain of .58% (443 up, 260 down) for the entire sample.

Stated otherwise, 70% of the time after a strong participation rise, we've had higher prices 20 days later, with superior average returns.

Yes, geopolitical events, large interest rate movements overseas, and other situational factors could change the equation quickly. So far, however, during this upmove, when we've had rises with strong participation, pullbacks have been relatively minor consolidations. Selling strong upmoves for an intermediate-term hold has not been a winning strategy for the better part of three years.