What Will End the Bull Market?
One of the most commonly asked questions among market participants and non-participants alike is, “What will cause the stock market to stop rising?” Normally, investors would be thrilled at the prospect of a perpetual rise in equity prices. Yet, with so few direct participants nowadays compared to former years, there is a growing desire among many for a major decline which will allow non-participants to buy stocks at a much lower price. As we’ll discuss in this commentary, that scenario will likely remain a pipe dream for an extended period before it ever becomes a reality.
The stock market’s relentless low-volatility rise with scarcely a dip along the way since August has left many observers scratching their heads. The market’s admittedly abnormal behavior in refusing to decline in the face of what is a technically “overbought” market condition will likely be a source of debate for years to come. One would probably have to hearken back to 1995 to see a similar episode in the stock market’s history. That parallel isn’t without merit, either, and may well prove instructive for the year-ahead outlook.
History shows that when volatility remains extremely low, while equity prices rise for extended periods, it typically precedes a period of economic outperformance. The stock market is after all a barometer of business conditions, as the legendary Charles Dow first suggested well over a century ago. His discipline, Robert Rhea, further refined Dow’s principles into what would become the famous Dow Theory. One of the basic tenets of Rhea’s version of Dow Theory is that movements in the major averages, namely the Industrials and the Transports, provide signals for business conditions with a lead time of approximately 6-9 months. Until the Dow Industrial and Transportation averages confirm a major trend reversal, according to Rhea, investors aren’t justified in anticipating depressed business conditions.
The gist of this idea is that it takes time for a well-established bull market to reverse; moreover, a major trend reversal is preceded by a period of distribution in which informed “insider” investors gradually sell their stock holdings so as not to attract too much attention from uninformed amateur investors. The shift in the sentiment among insiders can almost always be seen by watching the progression of internal indicators including breadth, cumulative volume, and 52-week highs and lows. When these three indications of the stock market’s internal health are diverging lower against the trend of the major averages, then and only then are investors justified in the expectation that a bear market is forthcoming.
Currently, all three indicators of the market’s basic internal health are still in good shape. Below is a graph of the NYSE advance-decline (A-D) line, which measures market breadth. Here you can see that breadth is still in a rising trend as more stocks are advancing than declining – a good indication that distribution isn’t underway.
Trading volume on the Big Board also continues to trend higher, as the following chart of cumulative (advancing minus declining) volume shows. A rising volume trend tells us that money is flowing in the direction of the prevailing trend, with more upside than downside volume. This is another confirmation of the stock market’s internal health. If distribution were underway, there would be more downside volume with a consequent declining trend in the cumulative volume indicator.
Finally, new 52-week high and lows on the NYSE are still in a rising trend as can be seen here. This is the strongest indication of all three major broad market indicators that there is currently no distribution (i.e. informed selling) taking place. When there is more selling than buying, it will always show up in the new highs-new lows indicator.
In view of how internally strong the stock market is right now, a distribution campaign of several months would likely be required to break the bull market’s back. As far as the “tape” shows, distribution hasn’t even started yet. The last time there was any sign of distribution was back in 2015, a few months before the stock market broke to the downside in August of that year. Even if we assume that informed investors will start unloading their stocks in the coming months, the bull market’s forward momentum would likely keep stock prices buoyant for many months before the bull breathes his last breath.
The most important consideration for investors now is that distribution hasn’t started and the bull therefore has at least several months of life ahead of it even under a worst-case scenario. So, instead of worrying about what might kill the bull, investors should instead focus on making as much money from it as they can while it still lives. The best way to do that is to maintain a bullish bias and avoid the temptation to sell short against a powerful rising trend.
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