Barry Ritholtz has an interview with Paul Desmond, President of Lowry's Reports, coming up this weekend and I'm waiting with bated breath. Paul Desmond has done some excellent work on how to identify market tops and bottoms. His work on market bottoms won the Charles Dow Award for excellence in technical research in 2002.
John Brooks from Lowry's wrote a bearish article early this year for Stocks, Futures and Options Magazine and I'm guessing Paul's thoughts will echo the findings of that article. From the February issue of SFO magazine, here are some highlights from John Brooks' article...
Historical cycles, indicators and supply and demand measures suggest a bear market lurks on the horizon, but you can protect your portfolio from a surprise attack if you know what to do.
There are very few constants in our business, but one facet that does come close to being constant is the four-year cycle. It is an interesting fact that the Dow Jones Industrial Average managed to make a low in 1950, 1954, 1958 and in 1962, right after the Cuban missile crisis. Carrying that pattern forward, there are bottoms in 1966, 1970, 1974, 1978, 1982 and 1987 (which was the first five-year cycle the market had seen for 37 years). This deviation from the norm may be explained by the fact that a new, powerful bull market had just started a few years earlier in August 1982, and the forward momentum was staggering to say the least. But regardless of the power that the market showed in the early ‘80s, we all paid dearly for that extra year in October 1987. That’s just the market’s checks and balances in action. Going forward, however, the market reached bottoms in 1990, 1994, 1998 and again in 2002.
Looking at the market from a longer-term basis you can spot enough cracks in the armor to provide fair warning. One such warning is the action of Lowry’s 5-day moving average (5-DMA) of new highs/new lows. Why use a 5-day? Simply to smooth out the numbers that can be distorted by daily noise. The peak reading for the highs was reached more than a year ago, and regardless of the rallies or news, we have seen a steady decline in new highs. These are not the numbers one would expect in a healthy market. In fact, the new lows part of this indicator has been expanding in recent market rallies.
Another worrisome indicator that should attract investor attention is the percent of New York Stock Exchange (NYSE) issues trading above their 30-week moving averages. Again, a series of lower highs in this indicator suggests that the rallies are becoming more selective.
The buying power and selling pressure readings are a graphic representation of the investment atmosphere and how buyers and sellers involved in the market are gauging their investments. The numbers of the buyers and sellers are accumulated to indicate the health of any market. With many of the major price indexes near all-time highs – or, at least, rally highs – one would have to expect that we would be looking at a dominance of buyers. Instead, selling pressure has been dominant since October 2005. Having sellers move into a position of strength does not in and of itself give us a sell signal, but it is the first step – a warning flag – that says this bull run may be near an end.
After advancing for more than three years, the stock markets are beginning to show signs of aging. The indicators are suggesting that the momentum and power on the tape is slowing, giving us signs of a possible reversal on the horizon. The small- and mid-cap issues that have been the backbone of this advance basically have doubled over the life of this bull market, and we now are seeing the money flow into larger capitalization issues – all normal action for the ending of the advance.