Opinion: Stock market bulls are playing with fire
There's a wide divergence in the number of stocks rising to highs and falling to lows, and that's a bearish indicator
Getty Images CHAPEL HILL, N.C. (MarketWatch) — Investors who are giving the bull market in stocks the benefit of the doubt are playing with fire. That's because the bear market's warning signals have created a situation as vulnerable to the slightest spark as a parched desert.
The latest warning comes from the so-called High-Low Logic Index. That well-regarded indicator was created by Norman Fosback in 1979, then the president of the Institute for Econometric Research, and currently editor of Fosback's Fund Forecaster. The index represents the lesser of two numbers from the New York Stock Exchange: new 52-week highs and new 52-week lows (both expressed as a percentage of total issues traded).
The indicator, therefore, is a measure of internal market divergences. In his investment textbook "Stock Market Logic," Fosback reasoned: "Under normal conditions, either a substantial number of stocks establish new annual highs or a large number set new lows — but not both. ... A healthy market requires some semblance of internal uniformity."
By this measure, the current stock market is anything but healthy. The 10-week moving average of weekly readings recently rose to 5.7%, well above the level that many researchers use as the threshold for a "sell" signal. (Fosback, for example, set this threshold at 5%, considering readings above that level as evidence of "extreme market divergence and ... bearish." The threshold employed by Ned Davis Research, the Venice, Florida-based research firm, is 4.4%.)
Why hasn't this dangerously lofty level of the High Low Logic Index received more attention? There are at least two reasons.
The first: The index has a better track record over longer, rather than shorter, spans, and its signals can be premature. Prior to the 2007-2009 bear market, for example, which began in October, the High Low Logic Index breached the 5 threshold in late July. So it's possible that some of the bulls are worried about the High Low Logic Index but are waiting for confirmation from other indicators before pulling some of their chips off the table.
The other reason that some are ignoring these latest warnings is that the index gave a number of false signals in 2013. As you can see from the accompanying chart, in fact, it rose to near 6 in the summer of 2013. (I wrote a column reporting its dangerously high level in August of that year.) Needless to say, the bull market didn't soon come to an end.
You'll also notice from the chart that the High Low Logic Index rose to an even higher level at the end of last year — hitting 6.9 in late December. It's too early to know whether that, too, will prove to be a false signal, though I would note that the Dow Jones Industrial Average is lower today than it was then.
One adviser who is particularly worried about the message of the High Low Logic Index is Doug Ramsey, CEO of The Leuthold Group. He points out that, unlike the situation that prevailed on the occasion of those false signals a couple of years ago, this time around there also is extreme divergence in the Nasdaq market, in particular.
In fact, Ramsey reports that a Nasdaq-only version of the High Low Logic Index just rose above its "sell" threshold for the first time since 2007. I need not remind you what happened at that time.
Posted by: sarah_oz@yahoo.com
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