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Dorn: Follow The Money

In my blog post on Tuesday morning March 10, 2009, I wrote, “ The cycle work and roadmap we have been following indicate that the patient may be starting to wake up - having been in its agonal stages and left for dead. When it turns, it could be shock and awefor a few weeks.”

On March 10, 2009, global equity markets experienced a strong rise after reaching new lows for the bear market. The markets have had strong moves before, only to turn back down and decline to previous lows or even new lows. Is it different this time? That is a dangerous question, but we are not ones to shy away from danger — so let’s see what the money is telling us.

We have never seen a market bottom on good news. Because markets are forward-looking, it is prudent to watch the reaction to news rather than the news itself. When selling is exhausted, stock prices rise even though negative news continues. One of the best ways to measure the strength of an uptrend is to examine the ratio of advancing issues to declining issues ( A/D) on the NYSE Composite Index ( $NYA).

My colleague Dave Harder examined every US stock market advance since 1970. Dave found that market bottoms were reached and strong uptrends followed when there were more than twice as many advancers vs. decliners for ten consecutive trading days (A/D10). This research does not tell us what analysts think should happen. It tells us what the money is doing. Dave’s A/D10 shows that money has been flowing into equities in a strong, unequivocal manner.

The A/D 10 occurred 6 times in the last 39 years—most recently on March 23, 2009. It also happened several weeks after the low in the 1973-1974 bear market and two weeks after the bottom in the 1982 bear market. Per Dave’s studies, the previous A/D 10 dates were: January 14, 1987; January 23, 1985; August 23, 1982; January 7, 1976; January 13, 1975; and December 7, 1970.

The first arrow on the chart below shows the A/D10 signal on January 23, 1985. Stocks advanced strongly for two years after that signal. The second arrow on the chart marks the A/D10 on January 14, 1987 that occurred after a six month consolidation. After this, the $INDU launched a 40% advance that ended eight months later in the Crash of 1987.

dow_1984_1988.jpg

From early 1973 to mid 1974 oil prices rose from $3.41 a barrel to $13.40-- an increase of 295%. Rising inflation, wage and price controls, the Nixon impeachment and a retreat from the war in Vietnam all contributed to a severe economic decline and a decline in stock prices very similar to the current one. As shown in the chart below, the A/D10 signal on January 13, 1975 marked the end of the bear market and the beginning of an advance that would bring the $INDU within 5% of the record high set in January 1973. Another A/D10 signal was triggered on January 7, 1976 when a strong advance started after a five month consolidation.

History may not repeat, but it often rhymes. Dave Harder’s work on the A/D10 coupled with the Big Rollover cycle work we have been discussing since 2005 plus the updates on our Tuesday Inner Circle conference call update indicate that we may be poised for a strong rise over the next few months with a high probability that the lows for this particular cycle have been seen. There will be fits ( some may “feel” scary) and starts along the way since nothing goes straight up, but these are likely to be “healthy” consolidation phases rather than new lows.

Even with Dave’s extensive studies from 1970 on A/D10 plus our work on the Big Rollover, we will take it one day at time and always let the markets show us their intention, rather than imposing our analysis on them. If you want to know what is going on, watch what markets do—not what people say they will do or are doing. To find a profitable trading edge, follow the money and take your lead from what it does.

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Janice Dorn, M.D., Ph.D., is a financial psychiatrist and chief global risk strategist for Ingenieux Wealth Management in Sydney, Australia. She also offer trading consulting and coaching services via her Web site, TheTradingDoctor.com.