As you can see by the chart, the advance/decline (A/D) line is well above its May highs of last year and in a pronounced uptrend. However, many analysts have been quick to point out that the A/D line also includes fixed income and closed end funds. If you eliminate this group and track common stocks only, you can readily see that the A/D line is not presenting all that bullish of a picture compared to the all-inclusive A/D line. However, despite the inability to make new highs, the common stock only A/D line has made excellent progress in recent weeks and, in the process, has broken through the upper boundaries of a bearish channel traced out from its bull market highs. Of course, this does not take away from the fact that the common stock only advance/decline line has fallen far short of making new highs and in the event of a breakout by the Dow or S&P 500, it will not be giving confirmation.
However, there was a similar situation earlier in the bull market. Again in reference to the chart, you can see that the common stock only A/D line made zero progress through the second quarter of 2011 through the end of 2012. It will be recalled that the market sold off sharply between late April and early October of 2011, with the S&P 500 losing almost -20% while the Russell 2000 dropped close to -30%. Over the same period, the all-inclusive A/D line gave ground which was quickly regained by year’s end, making new highs by early January while the equity-only A/D line continued to languish. In this instance, the all-inclusive A/D line was indicating in no uncertain terms that the bull market was alive and well, and indeed it was.
Whether it is going to be correct this time around remains to be seen. Our models are still negative, but looking better by the day. Our advice is to continue to remain cautious with a high cash profile, similar to our real money accounts.