Don't Give Up on the Bull Yet

10/05/2012 10:21 am EST

Focus: MARKETS

James Stack

President, Stack Financial Management

There is a lot of talk about how well the markets are doing, and sometimes that means it's a good time to take your profits and step aside…but not this time, writes Jim Stack of InvesTech Research.

Throughout the past 3.5 yearsm we have described this market as the most unloved bull market in history. It remains so today.

Yet even if it ends tomorrow or next month, it has been—and presumably still is—a bull market, with all major indexes except the Russell 2000 hitting new multi–year highs this week. [And the Russell 2000 actually did so on an intraday basis.]

  • The Dow Jones Industrial Average hit a new 4.8–year high this week, and remains only 4% from its all–time high from 2007.
  • The S&P 500 also hit a new 4.7–year high this week, and is 6.7% from its all–time high.
  • Likewise, the broader Wilshire 5000 is at a new 4.8–year high, and 3.8% from an all–time high.
  • The technology–laden Nasdaq hit a new 11.9–year high this week—its best level since the tech–bubble years of the late 1990s (and subsequent washout). The difference today is that valuations are nowhere near the extremes of that frenzy–driven period.
  • And, surprisingly, the Russell 2000 index of small–cap stocks is the closest to a record high (0.4%).

The stock market this year has defied the skeptics and bears. And after just nine months, this year’s gain has already doubled the 7.3% average election–year gain since 1900. That’s not bad, considering the widespread fears and economic headwinds.

Unfortunately, you can’t choose the period of history in which you get to live and invest. If one could, we’d probably all prefer to go back to the 1950s and 60s, when growth was steady, recessions were mild, and inflation/deflation fears for the most part didn’t exist.

No, you can’t choose the times in which you must invest—but you can choose how to invest in the times that you are given.

The Fed’s own “shock and awe” campaign has given an additional boost to the market, as all major indexes hit new bull–market highs. Yet the simple fact remains that even after $3.5 trillion in Federal Reserve debt purchases and government stimulus spending, this remains the worst recovery since the Great Depression.

There is increasing risk looking ahead at three leading US economic models, which have generally turned downward ahead of past economic recessions:

  • The Conference Board’s US Leading Economic Index has leveled off and is closing in on its 18–month moving average. A decisive break through that moving average, similar to 1990, 2000, or 2007, could signal the imminent onset of a recession.
  • Our “Shadow Leading Economic Index” saw its latest figure tick lower, while the previous four monthly readings were also revised downward. There’s no absolute “recession” level for this gauge, but the trend is clearly deteriorating.
  • The Philadelphia Fed’s Leading Index is now approaching a threshold that over the past 30 years has proven critical in warning of a possible recession.

These are all compelling reasons not to get caught up in the jubilation for the market's recent new market highs. A decisive break in any of these leading indexes will likely warrant a more defensive move on our part.

Nevertheless, the market's technicals remain strong. If the recent new market high somehow turned out to be the final bull–market top, then it would be unlike any market peak of the past 50 years.

Here’s why…breadth, as measured by our A/D Divergence Index and the Advance/Decline line, is usually one of the most reliable warning flags of a market top. At past market tops, there is almost always a negative divergence of some degree where the A/D line peaks ahead of the market and is already in retreat by the time the market tops out. That is not the case today.

Likewise, we see solid strength when looking at our InvesTech Bellwether Index, which contains leading stocks from the bellwether industries that commonly peak ahead of the market. These bellwether stocks are telling us that this bull market is most likely not over.

And when we look at leadership in our Negative Leadership Composite, we’re getting a more positive reading, instead of the bearish distribution that would warn of a pending bear market.

Bottom line? Our technical tools in breadth, bellwethers, and leadership are telling us not to give up on this bull market. And we have a lot of historical trust in their reliability.

Subscribe to InvesTech Research here…

Related Reading:

Economic News Points to One Winner

Gold Is Looking Better and Better

The World's Next Big Stock Rally

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