I swear for all the negative sentiment I am hearing about, I am reading positive stories about big Q4 rallies almost everywhere the past 5 or so days.
- Would you be interested in a market indicator that has correctly called every major market top and bottom in recent decades—with few false signals? Of course you would.
- And the good news doesn’t stop there: This exceptional indicator is currently in very bullish territory. The indicator I’m referring to is the High Low Logic Index, which was devised in the 1970s by Norman Fosback, then the President of the Institute for Econometric Research, and currently editor of Fosbacks Fund Forecaster. The index represents the lesser of two numbers: New 52-week highs and new 52-week lows with both expressed as a percentage of total issues traded.
- Higher readings of the High Low Logic Index are bearish, according to Fosback, as they suggest that “the market is undergoing a period of extreme divergence… Such divergence is not usually conducive to future rising stock prices, [since] a healthy market requires some semblance of internal uniformity.”
- Interestingly, Fosback found from his research, “it doesn’t matter what direction that uniformity takes. Many new highs and very few lows is obviously bullish, but so is a great many new lows accompanied by few or no new highs.”
- Fosback in the 1970s recommended a 10-week exponential moving average of the indicator, and this is the approach taken by Ned Davis Research. The firm each weekend updates a version of the index based on all publicly-traded stocks in the U.S. Its latest value is 1.7%, which is solidly in bullish territory.
- In fact, there have been only four other occasions over the last 25 years in which the Ned Davis Research version of the High Low Logic Index has moved from bearish territory above 4.05% to as low as it is today, and all four came close to a major market bottom: Late 1987, late 1990, early 2003, and late 2008.
- This last occasion represented the most premature the indicator came in anticipating a bull market, and even then it was only 3-4 months early.
- The threshold level that Ned Davis Research has used in its back testing to indicate bullish market breadth is 2.5%. Whenever the 10-week exponential moving average of the High Low Logic Index is below this level, according to the firm, the S&P 500 index has appreciated at a 17.9% annualized rate. Whenever it has been above 4.05%, in contrast, the S&P 500 index has declined at a 12.5% annualized pace. (interesting)
- Did this indicator anticipate the market’s weakness in August and September of this year? Unfortunately not, which is another way of saying that the message of the indicator is that recent weakness was not the beginning of a major bear market. The highest it ever got to was 3.2%, according to Ned Davis Research, a level that the firm’s back testing has indicated to be a neutral reading.
- The last time the indicator was higher than the 4.05% sell threshold was late 2007, just before the Great Recession and associated credit crunch. The bulls can only hope that the indicator will be as successful this time around as it was on prior occasions.
Trader Mark is the author of Fund My Mutual Fund.