All Systems Go for Undaunted Bull

05/03/2011 2:11 pm EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

The stock market’s ability to hold above key moving averages and generate daily gains for most stocks is a sign of strength, writes Dan Sullivan of The Chartist.

How can stocks continue to rise in the face of the seemingly insurmountable problems that threaten the global economy? So far, the stock market has shown remarkable resiliency despite a litany of concerns that could have—should have—done considerable harm to the bull market.

The market has stared down the smoking gun of conflicts in the Middle East, the Japanese crisis, ongoing European debt worries, and the massive US budget deficit, and has barely blinked. In the contradiction that is the stock market though, it is these very concerns that could be fueling its rise.

The wall of worry the stock market is climbing has kept a lot of money on the sidelines, which should fuel the bull market going forward.

The Dow Jones Industrial Average recorded bull-market highs today and is now within 10% of the all-time closing highs of 14,164 set on October 9, 2007. All of the major averages are above their respective 50-day moving averages, including the cumulative daily Advance/Decline Line, which is just off its most recent highs.

All of the key averages have been comfortably above their 200-day moving averages as well. The benchmark S&P 500 is now 10.22% above its 200-day line.

Many analysts feel that the gap between the S&P 500 and its 200-day line is indicative of a vulnerable and overextended market, but history has not borne this out over the past 20 years.

It is our feeling that the ability of the S&P 500 and other key averages to move as far as they have above their 200-day lines is a sign of strength. [The S&P 500 was 11.5% above its 200-day average as of Monday’s close—Editor.] Rather than being a prelude to a correction, it is a signal of extraordinary staying power.

The table below of the S&P 500 versus its 200-day moving average tracks the 16 times over the last 20 years in which the S&P 500 has moved from 9% or less above its 200-day moving average to 12% above.

Gurus Chart 1

As you can see, there was only one serious correction over this period. In the majority of the instances, the market worked its way higher over the next three, six, and nine months.

Just like overbought markets, so-called overextended markets can stay that way for considerable periods of time. The odds remain weighted on the side of the bulls.

The cumulative Advance/Decline (A/D) line recorded bull-market highs as recently as the end of April, confirming the bullish trend. This is significant from a long-term perspective, because the A/D line usually tops out well ahead of the overall market.

As an example, prior to the last bear market, it reached its highs of the cycle on June 1, 2007, while the overall market (as measured by the Dow) topped out on October 9, four months later.

Prior to the 2000-2002 bear market, the A/D line topped out in March of 1998. Before the October 1987 meltdown, the A/D Line peaked in late March—again ahead of the Dow, which recorded its highs in August. Before the 1973-1974 bear market, the A/D Line peaked four years ahead of the Dow.

As long as the A/D line confirms the trend of key averages, all systems are go.

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