The view from Wall Street: No ordinary rebound

US stocks continued their push higher as they gained for a third consecutive week.

The S&P 500 gained 0.9 per cent to 2,033.11 this week, its highest close since August 20 and its third week of gains. The Dow Jones Industrial Average advanced 0.8 per cent to 17,215.97, and the Nasdaq Composite advanced 1.2 per cent to 4886.69.

The S&P 500 has now gained 8 per cent since September 28, and InvesTech Research's Jim Stack calls this “no ordinary rebound.” The market, he explains, recently experienced “three solid ‘volume thrusts' over the course of just four days, culminating with a strong ‘breadth thrust' on day 10”. Stack continues:

A volume thrust is created when “up volume” (volume traded in advancing stocks) overwhelms “down volume” (volume traded in declining stocks) – and here we're looking for ratios of at least 5:1 or higher. Single volume thrusts can occur sporadically on any particularly strong market day, but closely spaced clusters of them are quite rare… [A] cluster of three such thrusts in four days has occurred only 10 times in the past 65 years and none of them were in a bear market.

More important for today's situation, a cluster of volume thrusts typically indicates a major change in momentum to the bullish side… the historical evidence is overwhelmingly positive. There were only two brief periods… when the market lost momentum in the weeks and months after this signal, and those losses were minor followed by a quick recovery. And in 9 out of 10 cases the S&P 500 showed solid double-digit gains both 6 months and 12 months after the occurrence of previous volume thrust clusters. Ironically, the exception was August 2009 which was five months after the start of the current bull market.

The presence of a strong breadth thrust over the same period provides further convincing evidence this was no ordinary rebound. These thrusts occur when the 10-day total of advancing stocks outpaces the number of declining stocks by a wide margin – usually by a ratio of 1.9 or more. Such breadth thrusts are a rarity near market tops and even more scarce in bear markets. When one occurs, it means that participation in a market rebound is broad-based across a high number of advancing issues. In other words, the rally is “firing on all cylinders”.

Wellington Shields' Frank Gretz agrees:

From mean-reverting… to nice reverting. There has been nothing mean about the market's recent reverting. It has been enough to suggest that it's more than just the proverbial oversold bounce. From the Trading Index to Marty Zweig's “Breadth-Thrust” Indicator, momentum measures say this rally is more than your garden-variety rebound. Is it a new bull market? In contrast to many, we're not sure the old one really ended. We see a good rally which likely will carry into year-end, call it what you like. The mean-reverting indicator we've emphasised all year has been the percent of stocks above their 10-day moving average. And it has worked quite well in its mean-reverting way – sell them above 80 per cent, buy them below 20 per cent. However, the recent peak of 94 per cent we think makes this time different. Like the other aforementioned indicators, this kind of momentum surge doesn't go away in a hurry.

Let's hope not.

This piece has been reproduced with permission from Barron's.