Advance-Decline Lines Confirm New Price Highs

247Bull.com Editor: It is at times like these that I am reminded of a quote by Danielle Park, author of the book Juggling Dynamite: “I think one thing is clear, that the stock market today is really a forecaster of absolutely nothing. It has lost all leading indicator ability and gives us no direction on the economy”. This is because the ongoing advance in US equities is being driven by unprecedented central bank liquidity, and not by sound fundamentals such as earnings growth. Sooner or later the structural problems that led to the financial crisis of 2008 will re-exert themselves. For the time being however, there is money to be made by being long risk assets, and considerable risk to being 100% in cash. This is a time to be well diversified and to own quality.

There are negative divergences on a lot of indicators we track (price makes a new high, but the indicators makes a lower high), but the advance-decline lines for breadth and volume are actually confirming the recent new price highs. This is reassuring but, it does not guarantee that even higher prices are coming.

As Yogi Berra once said, “You can see a lot by just looking,” and there is a lot to see on the following chart which shows the S&P 500 Index advance-decline lines for breadth and volume. I have annotated some of the variations of divergences and confirmations which can occur. Let me briefly discuss them.

First, I generally limit comparisons to periods of no more than about a year, because I don’t think that comparisons over long periods are valid. For example, I am not concerned that the current volume level has not exceeded the 2007 volume top.

1999-2000: We had mixed signals. Breadth diverged negatively, while volume confirmed the price high.

2002: There was a reversal divergence on breadth and a negative divergence on volume — a thoroughly negative picture.

2007: There were negative divergences on both breadth and volume. Not a good outcome.

2011: A reversal divergence on breadth and a negative divergence on volume.

The down-pointing arrows identify some of the times where a new high was confirmed by one or both of the advance-decline indicators. In those instances the price top was followed immediately by a price decline, or the confirmed top was followed shortly by a slightly higher top, marking the high before a significant decline.

Note: There are many other confirmations that resulted in positive outcomes. I’m only trying to illustrate that this is not always the case.

Conclusion

Indicator divergences should always inject a note of caution into our outlook, and it is best when the indicators confirm new price highs, but a confirmation doesn’t always mean that there is no immediate danger.

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