Fighting the stock market rally? – Do not ignore this indicator

Both the bulls and bears in the stock market were on opposite sides of last week’s CPI report. Those convinced that the stock rally from the June lows was just a pause in the bear market were expecting a much worse-than-expected CPI report. Instead, the report came in better than expected as stocks rocketed.

A Bloomberg article over the weekend began with “Supply bears are suddenly crushed.” They further noted that “sharp market reversals are confusing real money veterans, retail speculators and quants alike”. So what did they miss?

The S&P 500’s ability to break above the 4200 level probably caused even more short-coverage, but that shouldn’t come as a surprise given that I thought it was likely late July. My expectations for hedging shorts were based on strong technical data at the time and June reports that the dollar hedge fund short amount reached levels last seen in 2008.

Friday afternoon’s uninterrupted rally in S&P futures did not cause traders to pull back to hedge their short positions. I would expect next week’s Commitment of Traders report to show a significant drop in short positions on S&P futures.

There were plus signs across the board, led by a 5% gain in the iShares Russell 2000, up 5%, followed by a 3.7% increase in the Dow Jones Transportation Average. For a change, the S&P 500 ($SPX) outperformed the Nasdaq 100 ($NDX) by a margin of 3.3% to 2.7% ahead of the more growth-dominated $NDX.

The Dow Jones Industrials had a solid 2.9% gain, just ahead of the Dow Jones Utility Average’s 2.7% gain. The SPDR Gold shares had the smallest gain of just 1.6%. It is also important now that only the $SPX and $NDX are showing double digit losses since the beginning of the year (YTD). The NYSE’s single market was just as impressive as its price increases, with 2,695 issuance rising and just 788 falling.

But why is this important? In my opinion, the technical indicator based on this data is the most important measure, next to price, to determine the trend of the stock market. The advance/decrease line is a cumulative reading of net advances minus declines. I developed my unique A/D line analysis in the 1980s and have been using it ever since.

The NYSE Composite has stocks, bond funds and ADRs, therefore the data is referred to as issuances and not stocks. All of these issues are used in the NYSE All Advance/Decline rule. There is also the NYSE Stocks Only A/D line which is based on only the stocks traded on the NYSE.

In addition, I follow four other advance/decrease lines; the S&P 500 A/D, Nasdaq 100 A/D, the Russell 2000 A/D line and the Dow Jones Industrial A/D line. I’ve found that often one or more of the A/D lines, but not all, indicate a trend change, so I check all of them regularly.

It was my analysis of the weekly Nasdaq 100 Advance/Decline line in the week ending June 24e that there could be a more significant low, as I pointed out in “Don’t count on another rally failure”. The focus then was on the fact that when the Nasdaq 100 and Invesco QQQ
Trust (QQQ) hit new lows in the week ending June 17enot the Nasdaq 100 A/D line, line c.

The following week, line d, the A/D line moved above its WMA, adding weight to the bullish divergence. Over the next four weeks, the A/D line moved above resistance, line b, and has risen sharply over the past month. Similar action was evident after what turned out to be key market lows in February 2016 and December 2018.

Last week’s close was above the downtrend, line a. The weekly chart shows the move above the 38.2% Fibonacci resistance from November 2021, with the next target at $339, the 50% level. The main resistance of 61.8% is at $355.45. Typically, a close above 61.8% Fibonacci resistance confirms that the major uptrend has resumed.

In mid-March, the S&P 500, NYSE Stocks Only A/D and NYSE All A/D lines moved above their EMAs and turned positive, as marked by the green squares. By early April, they had all turned negative again and none of the weekly A/D lines showed any positive signs during this period.

The positive signals from the daily A/D lines at the mid-May lows (purple squares) did not last as long as market averages, such as the Spyder Trust (SPY

), was hit by another selloff as it fell to new correction lows. During both periods, the daily A/D lines formed lower price lows and did not form positive divergences.

That changed on July 14the when the NYSE Composite hit a new intraday low not seen in other indicators like the SPY or QQQ. This was significant because the NYSE All A/D line did not hit a new low and formed a daily positive divergence, line f. The move in the NYSE All A/D line above the EMA and then the resistance at line e was a positive development.

In the past week, all of these A/D lines have overcome their main downtrend lines a, c and d, which is a bullish sign from an intermediate point of view. It is also a good sign that the EMAs of the A/D lines are rising and rising sharply.

In my experience, using the moving average and trendline analysis on the A/D lines is the most reliable way to identify the lows of corrections. One does not always have to observe deviations from the highs or lows, but when they do occur, the signals can often be stronger. In A Survivor’s Guide to Market Corrections, I discuss several other important market corrections that can help you make better use of my A/D line analysis.

In the four straight weeks of solid gains, it wouldn’t be surprising to see a 1-2% pullback that could coincide with the option’s expiration this Friday. This should provide another good buying opportunity.

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