Using Moving Averages to Determine Long Term Market Bottoms:
Back on October 9, 2002 when the market formed a long term major bottom Les Horowitz's data showed his entire database was 90% below the 10 day, 21 day, 50 day and 200 day moving averages. Page down as there is lots of insight in the data:
On January 5, 2005 the market closed with 89% of Les's data below the 10 day moving averages. However none of the other moving averages look anything like the major bottom in October 2002. The next lowest number was 79% below the 21 day moving averages with all other numbers being higher:
Long term market bottoms are formed when the entire market is so oversold that 90% of stocks are below all meaningful moving averages.
However as nice as it would be to believe we can watch this data and know that typically the market will rise after such a notable event as having all the moving averages so low on a percentage basis it just is not a 100% certainty.
In fact on July 23, 2002 the number of stocks above the moving averages was even lower than it was on the ultimate bottom on October 9, 2002. Proving that even a reliable indicator needs confirmation in the form of positive divergences.
Anyway, getting 90% of the market below its 10 day sma is rare but not rare enough to portend a major market bottom. Even having 90% of the market below all its major moving averages will not do that. But positive divergences such as lower prices with more stocks above the 10 day, 21 day, 50 day and 200 day moving averages surely will in my humble opinion.
NYSE and NASDAQ Percent of Stocks above the 50 and 200 Day SMA's:
When only 10% of stocks are above the 50 day and 200 day sma as measured by the record percentage then we can be reasonably assured of a long term bottom. Using the 10 day sma alone would probably work well for a short term bottom but in my humble opinion nothing more.
This post was inspired by this article which contains data which should be questioned:
Editor's Note: This is a bonus story from Jon Markman, whose commentary usually appears only on RealMoney. We're offering it today to TheStreet.com readers. To read Jon Markman's commentary regularly, please click here for information about a free trial to RealMoney.
Virtually every major technical analysis shop and market timer in the country has declared the 2004 rally dead in the water over the past two weeks. But Florida-based Lowrys Reports is one exception. The firm has a great long-term record, so it's worth hearing its point of view.
I have mentioned the institutional advisory firm, of which I am a client, before. It is objectively focused on proprietary equity supply-and-demand measures. It was appropriately bearish during the 2000-2002 bear run and has caught turns back to bullishness beautifully -- first in mid-October 2003 and then with a timely and long-lasting bullish call in late March 2003. The firm was bullish, particularly on mid-caps and small-caps, all the way through the last three quarters of 2003 and into 2004. It remains so today.
I had a long talk on Wednesday with John Brooks, who has been at Lowry's since the early 1970s. He said that his team studies 145 market indicators, and he sees nothing more on the weekly charts today than a normal correction to the bull trend. He says that most of their short-term indicators are four-fifths of the way to oversold or better, and are thus very nearly ready for a full reversal.
Brooks notes that most of his clients, at funds large and small throughout the country, were skeptical of the bull market throughout 2004 and are thus somewhat happy to be vindicated with the recent selloff. In October and even November, amid the big speculative end-of-year run, he said, it was "like pulling teeth" to get people to buy stocks. So it's not a surprise to him to learn that so many managers are exhibiting a morose skepticism today. Confident Against the Herd Brooks is confident that sellers will be as wrong today as they were in October last year. The percentage of NYSE and Nasdaq stocks below their 10-day moving average is one indicator that he says has given almost perfect signals for the past 20 years, and it is giving a very clear buy signal now: When that number goes below 10% (i.e., 90% of all stocks are trading below their 10-day moving average), the market is typically much higher three to six months down the road. It was at the same level in August last year, and since 1990, the signal has tripped 15 times. On average, the market is up 4% two weeks later, up 11% three months later and up 24% one year later.
Through the end of Thursday's trading session, the number of stocks below their 10-day moving average had begun to hook up despite the decline in the broad indexes -- the type of divergence that sets up reversals.
Brooks says he believes the psychology of pros has been negative for a year, and most have wanted to be defensive. This explains why Lowrys' "selling pressure" index has hit record lows while "buying power" never gained a lot of traction.
Major fund managers were holding on to their stocks, expecting higher prices, but they weren't buying a lot of new stocks. That is pretty much the definition of a "wall of worry," and it can be very bullish as fearful investors are slowly but surely tempted to commit more funds to stocks.
Brooks thinks the Dow Jones Industrials will hit 11,700 midyear, then decline and rebound to finish the year at the same level. But that doesn't mean he is a long-term bull. In fact, he believes the market is tracing out secular bear-market behavior, and he believes the current period is more like 1971-1972 -- about a year from the brink of a precipice -- than 1982, the start of a long-term rally.
For now, he says Lowrys' work has shown over the years that you can't get a major decline without a buildup in selling pressure. In the second stage of a bull market, which is probably where we are headed, he says buying power and selling pressure move up in tandem as people are increasingly willing to liquidate positions. But even when selling pressure crosses above buying power, he says that's only a four- to six-month warning of a top ahead.
In sum, Brooks advises investors to stay focused on the healthy weekly advance-decline line, which suggests continued interest in buying a broad range of stocks. "When IBM gets to $101," he says, "every trader who's been sitting on his hands is going to say, 'What do I do now?' And then you're going to get a melt-up. The glass is not half empty, it's half full. .... This is not the start of a bear market. All that has happened is they've taken the cream off the top of the bottle."
If you like Brooks' view better than the nabobs of negativity, here are the big-cap stocks he likes.
Big-Caps Poised to Perform
Company Ticker IBM (IBM:NYSE) Wyeth (WYE:NYSE) Altria (MO:NYSE) Caterpillar (CAT:NYSE) Disney (DIS:NYSE) United Technologies (UTX:NYSE) DuPont (DD:NYSE) Johnson & Johnson (JNJ:NYSE) General Electric (GE:NYSE) Procter & Gamble (PG:NYSE) American Express (AXP:NYSE) American International Group (AIG:NYSE) McDonald's (MCD:NYSE)
At the time of publication, Markman was long General Electric, although positions may change at any time.
Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment research service, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. He also writes a weekly column for CNBC on MSN Money. While Markman cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jon.markman@thestreet.com.
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