Friday, July 24, 2009

When Market Strength Follows Market Strength: Shout Out to Market Tells

On Thursday, we saw a very strong market performance that was preceded by significant market strength. I was going to take a historical look at what to expect when strength has been followed by strength, but I see that the excellent Market Tells service has beaten me to the punch. They, in fact, looked at the strength-after-strength pattern in multiple ways, generating very interesting conclusions. I cannot recommend Rennie Yang's work highly enough.

One permutation of strength-on-strength that he examined was three days of higher highs and higher lows followed by a day in which stocks (S&P 500 Index) rose by more than 2%. Going all the way back to 1965, Rennie could only find ten previous examples of such strength. Here is what he has to say. (As noted above, I recommend you read the rest of his report, as his conclusions are drawn from multiple historical views).

A 2%+ up day for the S&P after multiple days of higher highs and higher lows doesn’t sound like a great time to buy. Prices are high, so it’s natural to wait for a pullback. The problem is that the pullback is often quicker and shallower than expected before the market takes off again. Here’s a look at all cases since 1965 in which the S&P gained 2%+ after three days of higher highs and higher lows. While there have only been ten cases, it’s noteworthy that the market moved higher over the next two weeks in all but one instance…

S&P500 2% Up Day After Three Days of Higher Highs & Lows

07/23/09… S&P500 ??? two weeks later
03/17/09… S&P500 +2.5% two weeks later
12/30/91… S&P500 +1.3% two weeks later
05/11/90… S&P500 +0.7% two weeks later
12/18/87… S&P500 +3.8% two weeks later
03/11/86… S&P500 +1.3% two weeks later
10/11/82… S&P500 -0.9% two weeks later
08/02/78… S&P500 +1.7% two weeks later
08/16/71… S&P500 +0.8% two weeks later
08/24/70… S&P500 +2.5% two weeks later
04/01/68… S&P500 +4.7% two weeks later

It is difficult to draw conclusions from a sample size of ten. What I find significant, however, is precisely how rare this pattern is. We are seeing market strength that is historically unusual. Moreover, if we examine the dates of the prior occurrences--such as 8/70, 10/82, 12/87, 12/91, and 3/09--we see that quite a few were early in bull markets.

It is indeed normal to look for pullbacks after market strength. When those don't materialize, it suggests that the buying is unusually persistent. In that context, historical patterns that *don't* materialize can yield important clues to the present market.