Saturday, 12 May 2018 11:00

An indicator that’s ‘90% accurate’ suggests hidden strength in the stock market

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The U.S. stock market may feel particularly risky right now, as major indexes have been volatile throughout 2018[1] and there are a number of headwinds that investors are monitoring[2], but things may not be as bad as they seem.

There are multiple signs of equity strength going on below the surface of the major indexes, which could be a signal that the recent uptrend in stocks is justified and could continue.

One positive signal looks at the ratio of rising stocks on the New York Stock Exchange to the number of falling ones over time. Paul Schatz, the president of Heritage Capital, referred to this as “the one indicator that’s 90% accurate” for forecasting moves.

Currently, the NYSE’s advance/decline line is at an all-time high, as seen in the following graphic from StockCharts, which Schatz included in an email.

image StockCharts data, courtesy Heritage Capital

“When the major stock market indices make new highs but the NYSE A/D Line does not, that’s where bulls should begin to worry,” he wrote, adding that “the exact opposite is happening,” which he said was “typically a good sign for further strength in stocks over the medium-term.”

Opinion: Bulls break the downtrend in stocks, but will it last?[3]

Both the Dow Jones Industrial Average DJIA, +0.37%[4]  and the S&P 500 SPX, +0.17%[5]  are more than 5% below their records, and they have been in their longest stretch in correction territory since the financial crisis.

The improving A/D line is an encouraging signal for the investors who have been worried about market breadth, especially as some of the market’s biggest names — notably the FAANG group of large-capitalization internet and technology stocks — have been leading the overall advance[6]. Because the market’s biggest companies have been seeing the biggest gains, those leaders can mask weakness in smaller companies. Schatz compared it to a building where the foundation “is full of cracks and is crumbling but the penthouse looks flawless with million dollar art and furniture.”

The improving breadth is helping to support equities, which can be seen in the broader indexes themselves. The Dow Jones Industrial Average, for example, is coming off six straight positive sessions, while the Nasdaq Composite Index is coming off five straight gains. The Cboe Volatility Index VIX, -4.38%[7]  is on track for its fifth...

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