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Our Outlook: Very Bullish for the Stock Market

February 4th, 2013

by Team

of Sadoff Investment Management

Our stock market outlook has shifted to “blue skies” ahead. Translated: very bullish for the stock market coupled with a “better than estimated” forecast for the economy. Major trend shifts are occurring. Let’s explain.

The Standard and Poor’s 500 advance/decline line has punched above its overhead downtrend line. In fact, it has pushed beyond its September 14th and April 2nd peaks. This action cleared out the overhanging divergence that acted as a caution signpost.

Score an upside breakout for the NYSE advance/decline volume reading. This indicator smashed above its overhanging downtrend line and above the two prior peaks (September, 2012 and March, 2012) and the peak in 2011. Very bullish.

The Value Line geometric index decisively pierced its three prior 2012 peaks (connected to form a downtrend line). This upside breakout cleared away another cautionary divergence. This price action is very bullish.

Most often the Dow Industrials and Dow Transportation Average trade in sync. Higher highs for one index result in a higher high for the other. The Dow Transports recently powered above its 1 ½ year downtrend line (which connected several intermediate peaks from the June, 2011 high). This 1 ½ year downtrend raised the caution flag. The recent upside breakout hoisted the “all clear” pennant.

Packaged together these four upside technical breakouts create a very, very bullish reading. That’s the language of the stock market.

An explosive upside volume pattern

The stock market often creates various patterns that sport an enviable track record. Upside, explosive volume creates a buy signal. On December 31st, the stock market exploded 300 points higher following the news that Congress passed legislation halting the “fiscal cliff” dilemma. More specifically, the upward volume on that day swamped the downward volume by a nearly 28:1 ratio. The next trading day, January 2nd, the advancing volume clobbered the declining volume by more than 11:1. These two powerful back to back volume readings created an upside explosion buy signal. The rule: one upside volume day of 10:1 or higher followed the next day by a 4:1 or more upside volume creates a buy signal. Certainly the December 31st 28:1 explosion and next day 11:1 blowout greatly exceeded our “buy signal” parameters of 10:1 followed by 4:1.

This pattern has occurred 14 times since 1958. The latest signal on January 2nd was the 15th. In summary, the average Dow performance results from these 30 buy signals are impressive. 3 months later, Dow up 9.5%, 6 months later, Dow up 15.6%, 9 months later, Dow up 21.8%, 1 year later, Dow up 20.4% (on average).

This explosive volume buy signal further confirms the strength of the four upside breakouts.

Percentage Change in the DJIA

Upside breakouts for financial stocks

Long lists of financial stocks (banks and stock brokerage firms) are breaking above their sharp, multiyear downtrends. These upside breakouts are important because the health of the financial industry is the backbone to our economy. Improving fundamentals for the financials result in easier money and credit so as to expand the economy. Just observe that these financial stocks are making successful, major pivots. Also notice that the major international banks (i.e.; Barclay’s Bank and Royal Bank of Scotland) are also developing major upside breakouts. The last massive upside breakout by the financials occurred in 1991, just as a major stock market multiyear advance was unfolding.

Improving commodity price pattern

Rising commodity prices generally foretell an improving economy and increased demand. Raw industrial commodity prices (the Journal of Commerce Index (JOC) and the Commodity Research Bureau Raw (CRB Raw)) trend and mirror the direction for the economy. Here’s a very oversimplified read: it is bullish when commodity prices advance and rise above its 200 day moving average.

Observe that the broad commodity price advance during 2004 - 07 coincided with an economic expansion. The commodity price breakdown in 2008 - 09 signaled and coincided against the Great Recession. Subsequently in 2009, commodity prices rose above the 200 day average for both the JOC and CRB Raw and eventually lifted this 200 day average. This signaled the pivot from a deep recession into a subsequent expansion.

Presently commodities are pushing upwards and recently surpassed their previous 4th quarter, 2012 peaks. This price action further validates a strengthening economy which in turn will support a rising stock market.

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