Better Days Lie Ahead

• More long-term US Equity indicators turning bullish
• The case for a spirited rally
• Testing the theory

At my webinar last week I pointed out a couple of observations on the US equity market. First, that more and more indicators are signaling a bull market. Second, there are some characteristics that suggested that we could see a really spirited rally unfold. Now that many of the short-term oscillators are overbought, the market has a great excuse to decline if it wants too. On the other hand, if this really is a bull market, it will shrug off that temptation and move higher. I’ll take those three points in order, starting with the bull market scenario.

More long-term US Equity indicators turning bullish

Chart 1 compares the NYSE Composite to its Special K indicator(SPK). You can read about here. In most situations this peaks and troughs with the price it is monitoring. This SPK is constructed from short, intermediate and long-term momentum.The trick is to try and identify these primary trend reversals as soon as possible. That’s done through price pattern analysis, trendline violations, MA crossovers, and spotting reversals in the peak-trough analysis. Chart 1 shows four previous signals, as flagged by trendline violation combinations of SPK and price. A fifth signal has just been triggered.

Chart 1

Chart 2 features the current setup in greater detail, where we can see that the $NYA has completed and broken out from a reverse head and shoulders. The SPK has violated its 2014-15 bear trendline, crossed its MA and traced out a downward sloping inverse head and shoulders. We can also observe a series of rising peaks and troughs. As far as I am concerned, this indicator is signaling it’s all systems go!

Chart 2

Chart 3 shows another long-term indicator, the Coppock Curve. It triggers buy signals (see the vertical green lines) when it drops below zero and then reverses to the upside. The Coppock Curve Indicator has historically been a pretty accurate gauge of emerging bull markets since the 1920’s. The false buy signal in 2001 warns us that it is not perfect. Holy grails in this business just do not exist. Nevertheless, if we are trying to identify and emerging bull market, I would far rather have Mr. Coppock on my side of the ledger than not.

Chart 3

It would be easy to parade many more of these reliable long-term indicators, but they are all telegraphing the same bullish message. That widespread commonality is a plus factor in its own right. There is one thing that bothers me and that is the overextended reading in the ratio between the Shiller P/E and the yield on Corporate bonds (Chart 4). This is a way of comparing the current return on stocks (earnings) to that of corporate credit (interest on bonds). The chart shows that whenever this series reverses from a very extended level, a major drop in inflation-adjusted equities typically follows. Right now the ratio is close to a record. That means that it had better not start to look down, or stocks will be vulnerable. However, my experience suggests that trend is more important than level. In that respect, the trend is positive because the ratio is above its MA and rising. I like to think of this as an elastic band. You can continue to stretch it, but at some unknowable point, it will snap. My comfort level comes from the fact that the overwhelming majority of the other long-term technical indicators have only just turned bullish, so as long as this one continues to work its way higher it’s something I can live with.

Putting it all together, it is possible that in terms of price we may well be currently positioned at the two dashed arrows indicating a failed signal. Under that scenario, we could expect to see a worthwhile advance, but the last one for the 2009-20?? bull market.

Chart 4

The case for a spirited rally

Technical analysis does not generally allow us to forecast the characteristic of an upcoming price move. However, there are some technical events that are often followed by above average price moves. One is a whipsaw or false move. An example is shown in Chart 2, as the Brexit crisis temporarily pushed prices below the 200-day MA and red up trendline.

Another is the formation of a broadening formation with a flat top, as featured in Chart 5. These are the opposite of right-angled triangles, where the lines forming the pattern converge. In the broadening patterns, they diverge as things gradually become unstable. These patterns are typically followed by price moves that are far greater than their size suggests. My theory on this is that they are really inverse head and shoulders formations, where the market is in such a hurry to move higher it fails to form the right shoulder.

Chart 5

Both the whipsaw and the broadening pattern characteristics point to traders being positioned on the wrong side of the market. This explains why price moves following these technical events have the potential to be explosive as those traders seek to get back onside.

Finally, Chart 6 shows the historical action of the DJIA in connection with Bollinger Bands. It is helpful to observe when the bands narrow. That’s because the narrowing process tells us when the battle between buyers and sellers is evenly matched. Such periods are often followed by above average moves when prices break in one direction or the other. I have flagged several instances in the past when prices have moved sideways, causing the bands to narrow.  When they subsequently widened prices experienced a worthwhile move to the upside. Sometimes it’s also possible to construct trend lines, the violation of which, signals an upside breakout. The recent 2014-16 trading range has caused the bands to narrow again and we can see in Chart 5 how prices have broken to the upside.

Chart 6

Testing the theory

Now that prices have bounced from their Brexit lows, several short-term oscillators have started to weaken. One of these is derived from the relationship between a 10-day (black) and 20-day (red) EMA of the NYSE McClellan Volume Oscillator. Sell signals are triggered when the 10-day crosses below the 20-day series from above zero. Recent ones have been flagged by the red arrows.  Most have been followed by a worthwhile short-term decline, so it will be interesting to see how the market handles the latest negative signal, triggered earlier in the week.

Chart 7

Chart 8 shows another short-term oscillator, a Percentage Price Oscillator (PPO) of the Dow. Once again we see a decisive sell signal, which again warns of some vulnerability in the period ahead. If this is a bull market, any correction should be contained, especially given the possibilities of the spirited rally scenario.

Chart 8

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.