Five Reasons To Stay Bullish

After moving up to the tune of +10.3% over the past five weeks, stocks finally succumbed to some profit-taking during Friday’s quadruple-witching expiration event. Despite the recent joyride to the upside and the fact that most trend and momentum indicators continue to suggest that one should side with the bulls, Friday’s decline seemed to cause the bears to come out of the woodwork. Everywhere I turned, I heard another “fast money” type explaining why the rally was over and that stocks could only go down from here.

While I have never had an affinity for making bold predictions about the stock market either publically or privately, I understand that when on T.V., making statements with conviction makes for a good segment. The bottom line here is no one remembers your comments on T.V. if you are wrong while being right tends to put you up on a pedestal. So, I get the fact that “taking a shot” and sounding convincing is a good thing for your career.

I also “get” that stocks have become very overbought, that investor sentiment has become too upbeat, and that the bears have been kept off the court for some time now. So, as we’ve been yammering on about for the past two weeks, a pullback in the near term would be neither surprising nor something to be terribly upset about. Remember, even the most bullish dances usually involve at least one step back after two steps or three steps forward.

Looking Past the Next Week

Before we go any further, I’d like to stress that the arguments about to be presented are not necessarily applicable to the next day or three. No, as we’ve been saying, a pullback is warranted right about now and it is important to understand that Ms. Market can do whatever she darn well pleases in the short-term. However, from a bigger picture standpoint, we would like to share a fistful of reasons to avoid jumping on the bear bandwagon.

Under the category of full and fair disclosure, I’d also like to point out that the indicators about to be discussed are definitely intermediate-term (or longer) in nature. This means that the timeframe we’re talking about is somewhere in the vicinity of 3-13 weeks.

A Fistful of Reasons

The indicators we’re about to review are designed to provide a view of the market’s internal technical health. We’ve found that as long as the market is healthy on the inside, it usually pays to lean to the long side. So, without further ado, let’s get to the indicators…

One of the best ways to determine the underlying strength of the market is to look at the health of the sectors, industries, and industry groups. For the record, our view of the world breaks the market into 10 sectors, 20 industry groups, and more than 100 sub-industries.

One of our favorite indicators of the state of the market is to look at the technical health of the market’s 109 sub-industries. History has shown that when the majority of the sub-industries are in good shape from a technical standpoint, the market tends to head higher.

According to the analysts at Ned Davis Research, 96 of the 109 (88%) sub-industries are currently considered to be technically healthy. This level is right on the line between moderately positive and positive. History shows that that the S&P 500 has advanced at an annualized rate of 11.5% when between 65% and 88% of the sub-industries are healthy and at a rate of 22.9% when more than 88% are considered technically healthy.

Next up is the concept of supply and demand. Logic dictates that when there is more demand (buying) than supply (selling), prices are likely to rise. So, the way we look at this idea is via up volume (demand) and down volume (supply). If one plots up volume and down volume on the same chart as the S&P, it becomes apparent that when the up volume line is above the down volume line, good things tend to happen. And the bottom line is up volume is currently well ahead of down volume. The computers at NDR tell us that the S&P gains at a rate of +15.7% per year when this situation exists.

Reason number three to stick with our heroes in horns is something Norman Fosback of Market Logic calls the High-Low Logic indicator. We’re not going to get into the gory details of exactly how this indicator works (such explanations tend to put readers to sleep quickly). However, we can say that the indicator is designed to tell us when the market is “in gear” in either direction. And in short, this indicator tells us that the market is indeed “in gear” to the upside at the present time. Historically, the S&P has gained ground at a rate of 19% per year when this indicator is in its positive mode.

Speaking of market breadth, long-time readers will likely recall that we have highlighted the positive aspects of a “breadth surge” (where the 10-day total of advancing stocks swamps the 10-day total of declining issues) several times over the past year. This is one of our absolute favorite big-picture indicators as 28 out of the 29 buy signals given since 1967 have been profitable one year later. Cutting to the chase, the most recent buy signal from this indicator occurred on February 19th. History shows that on average, the S&P is 13% higher six months after a buy signal is given and 17.5% twelve months out.

Finally, if the credit crisis taught us anything it is that markets are definitely global in nature. Thus, it makes little sense to limit our analysis of the stock market to just the United States. From where we sit, it is a good idea to get global confirmation of any move occurring here at home. In other words, bull markets tend to be global in scope, so if the U.S. is movin’ on up, then the rest of the world should be as well.

A simple way to make this confirmation is to look at the trends of the various stock markets around the world. And in scanning more than 40 global indices, we find that 95% are currently above their 10-week moving averages. As such, we can say that the global markets are in bull modes and are in tune with what is happening in the U.S. (or is it the other way around?). For the record, the stats show that the S&P has advanced at a rate of 26.2% per year when more than 70% of the world’s markets are above their 10-week ma’s.

To Sum Up

To sum up, our little analysis shows that 88% of the market’s sub-industries are in good shape at the moment; demand (up volume) is well ahead of supply (down volume); the breadth of the market