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A/D Breadth Thrust Suggests More Upside

Tuesday, October 07, 2003 | 02:29 PM

Markets completed their best week of the year, with all the indices up smartly. The Dow gained 259 points (2.78%), the S&P500 was up 33 points (3.31%). However, the real action was in Tech and Small cap: As the Nasdaq sprinted almost 90 points (4.94%), while the iShares S&P600 small cap index (IJR) gained 6.34%.

Consider that this occurred as investors were digesting several negative inputs: The G7 / weak dollar, pre-announcements, and OPEC’s surprise cut in oil output, which sent crude prices higher. All that negative news was countered by offsetting positives, including the pre-announcement period was better than expected, ISM numbers did not meet the worst fears of traders and the first decent jobs report in 7 months.

There are hundreds of reasons why the markets should be petering out here – not the least of which is overhead resistance (see nearby chart) – but based upon historical precedents, the technical action last week suggests the markets will be higher 3 months from now.

Consider the very positive A/D skew last Wednesday: the advancing issues beat declining issues by a very strong 4.8-to-1 ratio on the NYSE. It’s worth noting that such a positive skew is very rare – and usually bodes well for future market performance.

A recent report (Co-authored by FTN Research’s Tony Dwyer and SentimenTrader’s Jason Goepfert) analyzed that ratio over the history of the S&P 500. There have been "54 occurrences since 1965 of NYSE advancing issues beating declining issues by 4.5-to-1 or greater ratio.

Placed into the context of a market trading above its 200-day moving average (such as we are now), however, there were only 11 instances of such this positive breadth thrust. In 10 of those 11 instances, the markets were higher 3 months later, with an average gain of 8.3%. The maximum gain was 19%; the one loss was for 4.4% after the breadth signal of November 1979.

All told, this represents a significant correlation, in our view. Note this research is similar to the price/volume studies Ned Davis Research did in the 1980s; Its also comparable to the 90/10 volume/price research performed by Paul Desmond of Lowry Reports (and discussed in our Contrary Indicators work last month).