Over the last several months the stock market has weathered a decline of more than 10 percent in the value of long-term government bonds, worries about the situation in Syria including use of chemical weapons, and the dysfunction in our own government which took us to the brink of a default on some U.S. debt obligations.
Stock investors can be very fickle and for us to go through the last 6 months with only a couple very normal corrections on the order of 5% or so, is a testament to the health of the market at the present time.
There are other telltale signs which often signal that a rising market may be getting ahead of itself and is due for a significant correction. One of these is known and the Advance - Decline Line. This indicator tracks the number of stocks rising in price vs. those declining each day and the total is added to the previous day’s to build a chart.
Trouble is usually signaled when the major indexes like the S&P 500 are making new highs, as they have recently, but the A-D line is headed downward signaling there are more stocks declining than advancing. From the chart below you can see that this is not the case today, as the A-D Line has hit new highs along with the major indexes.
Another indicator which is not too different from the Advance-Decline Line concept is the relationship between small company stocks and large company stock prices. As bull (rising) markets age there tends to be a shift by investors from the smaller more aggressive companies to the larger, well-established companies which are able to weather the next inevitable economic slowdown with less impact on their business. This divergence in demand leads to large company stocks outperforming small company stocks.
In recent months, small company stocks have been the leaders of the market, not laggards. This leads me to believe that, at least with what we know today, we aren’t ready for the current bull market to roll over and become a bear (declining) market just yet.
Of course, we have another bear market in our future, and one after that, since they come around every few years. The question is when. Investors can succeed by riding bear markets out, and they can succeed by trying to side-step difficult markets using disciplined methods to protect your investments.
The thing we can say with certainty will not work is an emotional or panic based process of selling after too much of the decline has occurred, and then finally being comfortable enough to buy back in after missing much of the rising market. Obviously the goal is to buy low and sell high, not the other way around. Having a plan in place and some self-imposed rules to follow during the market cycles will be helpful in surviving the next bear market when it eventually arrives.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.