Will This Stampede Ever End?

04/15/2013 7:45 am EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Despite record highs, there are plenty of indications that the bullish market cycle will continue, writes Dan Sullivan of The Chartist.

While the economic recovery has been bumpy, one sector that has shown consistent improvement has been housing. With the Federal Reserve maintaining interest rates at record low levels, consumers have a strong incentive to make new home purchases.

According to the widely followed S&P/Case-Shiller Price Index, January prices rose at the fastest annual rate in more than six years. Based on its 20-city index, home prices increased 8.1% year-over-year and recorded the biggest jump since 2006, which was just prior to the burst of the housing bubble.

All 20 cities posted gains, compared with a year ago, with Phoenix the leader (up 23.2%) and New York on the bottom (up 0.6%). The good news for New York is it notched its first gain after 28 consecutive months of negative annual returns.

Despite the positive numbers, home prices remain nearly 30% off the peak levels reached during the housing bubble, but are moving in the right direction. With consumer demand and relatively low inventory levels, the positive trend should continue.

The market continues to grind higher, with all of the key indices above their uptrending 50- and 200-day moving averages. Its ability to ignore the Cyprus fiasco is extremely bullish for its prospects going forward.

Most of the key indices are either at or near all-time record high territory. The one exception is the Nasdaq Composite, which is well under its peak reading of the dot.com boom. However, it is currently at its highest level in over a decade.

Despite the gains that have been racked up, the market is not overbought at this juncture. It was heavily overbought on January 2, when our OB/OS Indicator hit +3.53. Since that time, the S&P 500 has gained +6.93%, and the OB/OS Indicator has contracted to a neutral +0.56.

Another way we measure Overbought/Oversold levels is by tracking the ten-day moving average of Advances versus Declines. We consider 1.40 or above to be indicative of an overbought market, while 0.75 or lower is oversold. It is currently at a neutral 1.03.

If history is any guide, stocks are going higher over the next several months. We saw an interesting chart previously detailing how the Dow performed after an intervening bear market. This has happened ten prior times since 1929, with the Dow gaining 2.36%, 6.19%, and 10.16% over the next three, six, and nine months.

Another bullish prop has been the record number of common stock buybacks announced over the past six weeks. According to Trim Tabs, companies have bought back in excess of $120 billion. In addition to this, there has been a well above average number of cash takeovers.

It’s interesting to note that for the entire year of 2012, companies bought back $248 billion. At the current pace, buybacks would be over $900 billion by the end of the year.

Many analysts who are in the bearish camp point to the last time the Dow was at historically high ground and its aftermath. The last gasp of the bull market was on October 9, 2007.

From that point on, it was all downhill, with the Dow tracing out a pattern of declining tops, and in the process breaking through key moving averages. Over the next three months, it proceeded to drop 15% and by the end of the bear market on March 9, 2009, it had dropped a devastating 53%.

One difference between the two periods is that no one was looking for a collapse in 2007, while this time around, a large percentage of stock-market participants feel that it is on shaky ground.

The real difference between the two time frames is that back in October 2007, the market’s subsurface was considerably more vulnerable. The Advance/Decline Line had topped out in early June, while only 52% of the stocks on the NYSE were above their 200-day moving average. Currently, the Advance/Decline Line is in record high territory, accompanied by 72% of NYSE stocks above their 200-day lines.

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