Our current bull market has lasted for over 10 years. Without any doubt, it will be over one day. Based on the historical precedents, the market breadth indicators will give us enough clues to get ready for a new bear market. Let’s examine two recent tops of 2000 and 2007 to see how the Advance-Decline Line behaved during those two periods and see if there are any warning signs today of a potential reversal.
Before I bring up the charts, let’s see what this magical advance-decline line is:
“The Advance-Decline Line (AD Line) is a breadth indicator based on Net Advances, which is the number of advancing stocks less the number of declining stocks. Net Advances is positive when advances exceed declines and negative when declines exceed advances. The AD Line is a cumulative measure of Net Advances, rising when it is positive and falling when it is negative. “
I usually plot the AD Line against the index to compare it to the performance of the actual index. The AD Line should confirm an advance or a decline with similar movements. Bullish or bearish divergences in the AD Line signal a change in participation that could foreshadow a reversal.
The 2000 top saw an extreme version of a bearish divergence. As the market continued to climb higher in 1999 and 2000 (albeit the rise was not smooth at all) the AD line has been gradually going down for almost one year. This formed a significant bearish divergence and it was just a matter of time for the indexes to reverse.
The 2007 top was more abrupt compared to the one in 2000. The S&P500’s broke out to new highs of 1575 in October 2007, however, this move was not ‘confirmed’ by the AD Line. Sure enough, the October 2007 became the top of the 2003-2007 bull market. We know quite well what happened in the next 1.5 years.
Our Current Market
During the last several years, the S&P500 made 3 new big highs (Jan’18, Oct’18 and July’19), which are now used by many technical analysts as the top resistance of a broadening megaphone formation. Most believe it is a bearish formation and the prices should see a big drop in the next several months (e.g., ‘a screaming sell signal’).
Notice, however, that the AD Line hasn’t developed a bearish divergence with these 3 highs on S&P500. In fact, the AD Line has been ‘leading’ the market and making new all time highs on a consistent basis during the last several years.
While the 2009-present bull market is definitely stretched by any historical measure (this is one of the longest bull markets in the last 100 years), the AD Line breadth indicator hasn’t provided us with any bearish divergences so far despite the fact that we saw a huge sell off phase in October-December 2018. In fact, the AD Line ‘suggests’ that the market might move to new all time highs later this year.