Advance/Decline Line Confirms Breakout
What increases the upside odds is the fact that the market also has strong breadth and momentum going for it. As you can see by the chart, the Advance/Decline Line confirmed the recent breakout of other widely followed indices when it moved through its December highs with authority. The A/D Line had previously recorded its highs of the cycle in the middle of May and failed to confirm the breakout of key averages in July. This raised a warning flag at the time because as you know the A/D Line tops out in most instances well ahead of the overall market.
Another positive was the upside momentum generated on the breakout. This is borne out by the 10-day moving average of advancing stocks versus declining stocks which moved all the way up to 1.82 on October 22nd, putting it within striking distance of a Chartist momentum thrust buy signal. Long term readers of the Chartist know that it takes a reading of +2 or higher for this to occur. In the past, readings of this magnitude have produced well above average gains over the next 3, 6, and 12 month periods. Note: Momentum buy signals are very rare. Since 1949 there have been only 18 signals.
However, the peak reading of 1.82 accompanied by the breakout of the A/D Line is still quite positive. Since 1970, there have been 21 occasions in which the 10-day moving averages of advances versus declines reached 1.80 or higher. After each occurrence, the S&P 500 gained +4.42%, +11.72% and +15.76% over the next three, six and nine months. As you can see by the printout, the average percentage gain by the S&P 500 after each signal was well above the market’s average performance over the three time frames. Unlike a +2.0 reading which has worked almost to perfection, there have been some notable periods of underperformance but overall, readings of +1.80 or higher have produced above average gains especially over the nine month period when the S&P 500 finished in positive territory 19 times with only two losers -4.82% in 1978 and -2.12% in 1992.