Mixed Signals

david —  September 26, 2013

Today John Kosar of Asbury Research.com put out the following note indicating a similarity in the market action of today’s market and 1999. John is a very respected market technician worth paying attention to. I will let his piece speak for itself and then present one important factor that is different today and some perspective after that.

By John Kosar, CMT—-Many professional investors use market internals to measure the quality of the trend in a stock market index. One such indicator is the Advance/Decline Line, which is used to confirm both the internal strength of a price trend and its potential vulnerability to a reversal. If the market index is rising while the A/D line is rising, it typically indicates a healthy trend that is likely to continue. Conversely, a rising index amid a declining A/D line indicates a market that is rising on the backs of fewer and fewer stocks, which often results in a market peak and subsequent decline in the index. Another potential indication of an upcoming bearish reversal in a stock market index is when market breadth becomes too bullish or frothy, which can indicate an over-extended condition that often occurs at the end of a price trend.

The chart below plots the NASDAQ 100 (NDX) weekly since 1998 in the upper panel, with the index’s Advance/Decline Line plotted in the lower panel.

The red highlights in the lower panel point out that, as of the close on Friday, the NASDAQ 100’s A/D Line is testing its March and August 2000 all-time high. The chart shows that this historic frothy extreme preceded a major peak in NDX 13 years ago, and warns that this over-extended condition could help to trigger a corrective decline in the index now. The red vertical highlights between both panels point out that previous, lesser peaks in the A/D Line, in January 2004, November 2007, and April 2012, all preceded significant declines in the NASDAQ 100, which tends to lead the US broad market both higher and lower.

So, while the bellwether S&P 500 is making new all-time highs and the financial media is clinking champagne glasses to celebrate it, keep a close eye on the NASDAQ 100’s A/D Line for a potential indication of an overdue corrective decline.

John Kosar, CMT, has 30 years of experience and insight in covering the global financial markets. John spent the first half of his career on the trading floor of the Chicago futures exchanges, where he had the opportunity to learn how the US financial markets work from the inside out. This experience, early in his career, became the foundation for the unique analysis, insight and perspective that defines Asbury Research. John is frequently quoted in the financial press both in the US and abroad, and can be seen regularly on U.S. financial television. Follow him on Twitter at:@asburyresearch.

Now the counter piece from Chart of the Day with my comment below:  PEs are nowhere near where they were in 1999

A recent Chart of the Day illustrates the price to earnings ratio (PE ratio) from 1900 to present. Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive. From 1900 into the mid-1990s, the PE ratio tended to peak in the low to mid-20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s), surged even higher during the dot-com bust (early 2000s), and spiked to extraordinary levels during the financial crisis (late 2000s). Since the early 2000s, the PE ratio has been trending lower with the very significant but relatively brief exception that was the financial crisis. More recently, the PE ratio has trended higher (to around the 19 level). However, over the past five months, corporate earnings have increased enough to maintain a relatively flat PE ratio — an overall positive for the stock market.


Chart of the Day

So whats an investor to do? Is either position correct?  Can they both be correct?  What should we do since prediction is difficult, especially about the future?  I think the answer is to be mindful that over the long term market prices are driven by value but over the short and medium term prices can be driven by emotion.  The chart from Asbury is charting behavior which leads to emotion while the chart from COTD is keyed from statistics.  We all know that eventually the market will correct but we don’t know when.   Therefore we are using stops (on individual stocks) and hanging in there with one eye on the emotional button as emotions can change quickly!

Call us at 310-459-9196 if you have any questions!