No major top

When I wrote the article for the previous issue of this magazine this past March, the Dow Industrial Index was at 8906. For the week ending May 15, the index stood at 9096, a mere 190 points higher which, at these levels, doesn't mean much. What is interesting is the fact that many of the indicators have pulled back from over-bought territory to near over-sold levels. For example, the 5-week A-D Ratio is down to 45.6% from 59.3% and the percentage of stocks above their 10-week moving averages has dropped from 71.4% (above 70% is over-bought) to 34.2% (under 30% is over-sold). Even the percentage of stocks above their 30-week moving averages has pulled back to a neutral 55.6%. Yet the RSI's for the major indexes are all up in the high 70s.

In Toronto, the situation is, as you might expect, very similar. The TSE 300 is up 272 points since March. However, the 5-week A-D ratio is down to 46.2%, the percentage of stocks above their 10-week moving averages has dropped to 32.1%, and the percentage of stocks above their 30-week moving averages has fallen to 52.3%. Yet the RSI's for the major averages are in the 80s and 90s.

In other words, many stocks have declined but that situation is not reflected in the indexes because a few heavilyweighted stocks are holding them up. The weekly Advance-Decline Line in New York is beginning to diverge from the indexes. That means that more stocks are going down than up. Also, the number of stocks making new weekly highs has dropped from 731 in March to 251 as at May 15. Until the indexes back off, rallies are likely to be narrow and declines broadly-based. It wouldn't hurt to take some chips off the table.

There's an old adage "Sell in May and go away." Historically, that has been pretty good advice. Yale Hirsch reports in a highly acclaimed publication the Stock Trader's Almanac that, over the past 50-odd years, the most profitable time to be in the stock market has been from November 1 to April 30 and the least profitable time has been from May 1 to October 31. The same amount of money invested each year between November and April in that 50-year period is worth about eighteen times as much as money invested between May and October.

Having said all of that, you might be wondering why there is a picture of a bull at the top of this article. Well, I don't think we are seeing a major top forming yet. There is evidence that trouble is brewing because the U.S. Dollar's volume line has given a sell signal on both a weekly and monthly basis. The dollar normally leads the bonds which in turn lead stocks. However, it often begins its descent by as much as a year ahead of the bonds or at least by several months. I hasten to mention that this time frame is not carved in stone. It could be shorter and, while I see indications that the bonds may suffer a bit more weakness in the near term, their volume lines are holding up extremely well. So, I don't think it's all over for them yet and, therefore, it's not likely over for stocks either.

I always like to dwell for a moment on market sentiment because it is one of the most important indicators in the technician's arsenal. As most of you know by now, I favour the Advisory Service Sentiment data reported by Investors Intelligence. The Bulls got very close to the danger level of 55% on April 17 by rising to 54.6%. However, since then they have backed off to 47.5%. The Bears are currently at 25.0% which leaves the spread between the Bulls and Bears at 22.5%, well below the danger level of 35%.

At the moment, the best sectors to be invested in as far as stock groups are concerned are interest-sensitive, consumer staples, and technology. Not much new on that score. The worst sectors are the natural resources with the possible exception of gold which moves in the opposite direction to the U.S. Dollar which, as mentioned earlier, has given a sell signal. As for most of the rest of the resource commodities-opper, crude oil, natural gas, and lumber-all I can see is further downside at the moment. Their volume lines are very weak, so stocks related to them should, for the most part, be avoided.

PATRICK TAYLOR IS AN INDEPENDENT TECHNICAL ANALYST.

Copyright Canadian Shareowner Magazine Inc. Jul/Aug 1998
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