Buy, Buy, and You’ll Fare Well

by | May 28, 2004

Are your surprised that the stock market has broken out of its funk this week, even though it practically seems like the world is coming to an end? If you’ve been reading this column, you shouldn’t be. Last week I said don’t worry about high oil prices (they’ll come down — it has already started). […]

Are your surprised that the stock market has broken out of its funk this week, even though it practically seems like the world is coming to an end? If you’ve been reading this column, you shouldn’t be. Last week I said don’t worry about high oil prices (they’ll come down — it has already started). A week earlier I said not to listen to the politicians talking down the economy (it’s still booming). And the week before that I said not to be afraid of rising interest rates (they’re good for the economy).

One investor who wasn’t surprised is my old friend Fred Goodman, one of my earliest mentors when I was first learning to be a professional investor 25 years ago. For all those years Fred has stuck to an iron discipline of careful technical analysis. It has always kept him out of trouble — and this week it kept him from getting shaken out during a scary market correction.

After the market closed on Monday, Fred published a report on my Web site issuing a buy signal on the stock market. It was a special signal this time, too. It was a double signal — a new buy signal on top of a buy signal that was already in force — and that’s something that has happened only five times over the last five years.

I don’t worship at the altar of technical analysis by any means, but Fred has an amazing track record — so when he says “buy” or “sell,” I at least listen. Especially this time, with his double buy signal. Of the past double buys, three out of four have been winners, with the S&P 500 higher over the following six weeks anywhere from 5% to 16%. The one loser logged a trivial loss. So far, so good on this one. Since Monday’s close, the S&P 500 is up 2.4%, the Dow is up 2.5%, and the NASDAQ Composite is up 3.2% (through Thursday’s close).

I think there’s more to come, in part because this double buy signal comes from a composite “Summary Index” of dozens of indicators — and many of them have been deeply in negative territory. Fred tells me that some of his indicators are at levels rarely seen — at major bottoms. The first of those are just now starting to recover, and that’s just the right time to buy.

Fred tells me that on Thursday, one particular indicator that has never been wrong in more than half a century gave a buy signal. It’s only the 14th time it’s given a signal since 1953.

This indicator was developed by Marty Zweig and first presented in the original 1986 edition of his classic book Winning on Wall Street. It’s called the 10-day advance/decline indicator. To calculate the indicator, you start with the daily advance/decline ratio — the number of advancing stocks divided by the number of decliners each day. Then you take the average of that ratio for the last 10 days. You get a buy signal when that moving average of the ratio gets above 2-to-1. That’s where it got yesterday.

Fred tells me, “Between 1953, when Zweig started keeping track, through 1996, when he wrote it up in the second edition of his book, there had been just 11 times when the 10-day average ratio gave a buy signal by reaching two advances to one decline. The return from buying the S&P 500 over these buy signals averaged 7.5% over three months, with 10 winners and only one loser — which was just 1.2%. For periods of six months after the buy signals, the average gain was 15.2% with no losers.”

Fred says that there have been three additional buy signals from Zweig’s indicator in the years since the second edition of his book came out. One was in May 1997, which resulted in a three-month gain of 10.6% and a six-month gain of 8.2%. The second was in June 2003, which resulted in a three-month profit of 3.2% and a six-month profit of 7.2%. The third was yesterday.

“Combining all 13 completed buy signals,” Fred says, “the average three-month return was 7.4%, and the average six-month return was 14.0%. If history repeats itself we can expect the S&P 500 to be at 1204 in August and 1278 in November. Of course, there is no guarantee that history will repeat itself.”

I really like this indicator because it’s simple and unambiguous. And of course I like that it’s been such reliable winner. But I also like the fact that it doesn’t seem to want to play the hero — it’s not trying to buy the big bottoms when opportunity may be greatest, but risk is greatest too. This indicator’s average six-month gain of 14% is terrific — that’s well above the average six-month return for the market. But obviously it’s not catching those rare and wonderful six-month periods when the market makes a 40% surge — and neither is it taking the risk of that kind of period.

That fits very well with the way I see the market right now, too. I think we’re going higher, and it’s worth being in the market. We’ve been in a correction, and we’ll come out of it. But I don’t see this moment in market history as one of those pivotal bottoms that give birth to stellar upward moves.

That said, this week Fred has noted other tried-and-true indicators that have also turned up — and some of them are behaving as they behave at important market turning points. Ned Davis’s famous indicator based on the Value Line Index has given the kind of strong signal associated with major bottoms. And an indicator based on NYSE up volume and a percentage of up volume plus down volume, developed by the Lowry Reports, is now registering at high levels typically associated with major upside moves.

Come to think of it, with so many things going wrong in the world, and with America’s political life gripped by what I see as bitterly divisive partisan warfare, this would be a pretty unlikely time for a big rally, wouldn’t it? Well, come to think of it, has there ever been a rally that occurred at a likely time?

Remember — the market’s job is to mess with your mind and force you to make mistakes. Its mission is to fool you and embarrass you and humble you. So wouldn’t the perfect thing for the market to do right now, in these troubling times, be to go up?

Think of your portfolio as an airplane, and you are the pilot. The news background is the heavy fog surrounding your plane, but it’s up to you to land it anyway. Technical indicators can be your instruments. When you can’t trust your eyes, you can trust your instruments!

But keep your seatbelt fastened just in case.

The following is an “Ahead of the Curve” column published May 28, 2004 on SmartMoney.com, where Luskin is a Contributing Editor.

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Don Luskin is Chief Investment Officer for Trend Macrolytics, an economics research and consulting service providing exclusive market-focused, real-time analysis to the institutional investment community. You can visit the weblog of his forthcoming book ‘The Conspiracy to Keep You Poor and Stupid’ at www.poorandstupid.com. He is also a contributing writer to SmartMoney.com.

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