A time for patience

TECHNICAL INDICATORS

Volume Line: Indicates changes in the amount of money coming into, or leaving, an equity market (or a stock). Money coming in is bullish because it represents accumulation of stocks-presumably by informed people; money leaving is bearish because it represents informed reductions of positions in stocks.

Relative Strength Index ("RSI"): Indicates the momentum of a market (or stock) during the last 14 weeks. A market (or stock) is considered overbought (time to sell) when its RSI moves above 70% and over-sold (time to buy) when the RSI moves below 30% (see May/June 1993 article). The Volume Line and the RSI are best used together to provide Buy and Sell signals. The RSI should always be viewed as subordinate to the Volume Line.

Buy Signals

When an index (or stock) reaches a new low level (price) without the Volume Line also making a unique new low (i.e. failing to confirm the new low level) and the RSI is over-sold (ie. below 30%).

A major advance can be expected when both the Volume Line and RSI fail to confirm a new low for an index (or stock).

Sell Signals

When an index (or stock) reaches a new high level (price) without the Volume Line also making a unique new high (i.e. failing to confirm the new high level) and the RSI is over-bought (ie. above 70%).

In the July/August issue, I quoted the old adage "Sell in May and go away". That turned out to be even better advice than I envisioned at the time. I fully expected the markets to rally after the bottom gap of the TSE 200 was filled in but then out came the Russian collapse which the market had obviously not discounted.

On a weekly basis, the Dow Industrials dropped about 18% between the top at 9338 on July 17 and the low on September 4 at 7640. The 5-week A-D Ratio got down to 31.5%. I've never seen it that low in New York. The percentage of stocks above their 10 and 30week moving averages (10/30s) plummeted to 8.3% and 11.5%. To put that in perspective, in the 1987 crash the 10/30s collapsed to 5% and 8%.

On a weekly basis, the TSE 300 dropped 26% from the high at 7765 way back on April 17 to 5743 on September 4. The 5-week A-D Ratio got down to 23.5%. I've never seen it in the 20s. The 10/30s fell off the cliff and almost went to zero at 2.4% and 3.0%. Again, I've never seen readings that severe.

So, no matter how you cook it, the markets are extremely oversold. Furthermore, at the September 4 lows, the A-D Ratios and the 10/30s had come off their lows and did not confirm.

The only index which gave a sell signal was the Dow Transports. The last highs for all the other New York and Toronto indexes were confirmed by their volume lines. The same is true for most of the major foreign markets such as the London FTSE 100, the Frankfurt Dax-40, the Paris CAC-40. So, the volume lines are telling us that the markets should go back up and exceed their previous highs. However, after a drop like we've just had, that's not likely to happen quickly.

A BEAR MARKET

So, why is there a bear at the top of this article? Well, you may recall that sometime back I wrote about Leon Tuey's TSE Momentum Index which is a yearover-year rate of change. "A buy signal is given two months after the TSE Momentum Index drops below the 10% reading (a loss of more than 10% on a year-over-year basis). Since 1945, the buy signals have been consistently profitable." At the end of August, the Index stood at -16.4%. The key words in Tuey's statement are two months. Two months from the end of August is the end of October. That gets us out of the traditionally bad period for the markets, that is, May to October, and into the usually profitable November to April period. So, I wouldn't even think about buying until November.

To add fuel to this negative fire at the moment, the volume lines of the major indexes in North America and Europe still don't show any signs of accumulation and the Nikkei Dow's volume line is still making new lows which is saying that there's likely to be more trouble on the Asian front. No doubt that will twist Greenspan's arm to lower interest rates. If he does, the market will love it. The U.S. Bond market has been exceptionally strong of late which is, I think, partially a flight to safety but also a prediction of a rate cut.

One other piece of the puzzle is missing and that is the sentiment in New York. The percent of Bearish Advisory Services currently stands at 45.7%. It got to 47.5% two weeks ago before backing off this week. We should see readings in the mid SOs before this market puts in a solid bottom.

PATRICK TAYLOR IS AN INDEPENDENT TECHNICAL ANALYST.

Copyright Canadian Shareowner Magazine Inc. Nov/Dec 1998
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