The market may be overbought, but conviction of this sort doesn’t come around very often, writes Dan Sullivan of The Chartist.
It is our contention that the bull market, which is approaching the two-year mark, has several more months to run; however, with more and more market participants piling into the bullish camp it was becoming increasingly apparent that something had to happen to shake up the overwhelming bullishness.
During last month’s retreat, the S&P 500 finally dropped below its ten-day moving average after holding above it for 34 consecutive trading sessions. The last time it traded above its ten-day line for 30 sessions or more was back in December of 2003 spilling into January of 2004.
This type of persistency tends to discourage short sellers and frequently sets the stage for corrective action. When the ten-day line was finally broken on Jan. 28, 2004, the S&P 500 dropped another 6% over the next six-plus months.
Whether we are in for a rerun remains to be seen. Our longer-term models are solidly bullish, so that is a big plus.
In addition, our Volume Thrust Indicator flashed three consecutive buy signals during the second half of 2010. Volume thrust buy signals are extremely rare because you need two consecutive days in which upside volume overwhelms downside volume. In order for a buy signal to be generated, upside volume must exceed downside volume by over ten to one on day one and four to one on day two. Frequently you will see upside volume lead by ten to one or more during a single session but with little follow through the following day.
During the last bear market, there were several occasions in which this occurred. The one-day rallies were certainly impressive, with upside readings coming in at 20.9, 19.6, 10.1, 18.3, and 18.8; however, the follow up readings frequently saw downside volume leading, and when upside volume led, it was always under two to one.
The key here is the follow up day in which upside volume must lead downside volume by at least four to one. As you can see in the table below, there have only been 14 volume thrust signals over the last 50-plus years, with the Dow gaining 9.76%, 15.64%, and 23.66% on average over the next three, six, and nine months.
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