IRA Investing: Market Breadth Remains Bullish

I'm really looking for reasons to take a more cautious stance toward the market. I'm very aware that we have had a mainly straight-line move upward since early 2003. But I can't argue with my indicators, and they continue to forecast higher stock prices in the future.

Advance/Decline Leads the Way

One indicator that did an excellent job of forecasting the big bear market of 2001-2002 was the cumulative advance/decline line. In 1998 and '99, while the S&P 500 was continuing to trend higher, the advance/decline line was actually trending down. This was a sign that the internal strength of the market was declining and that a cautious stance was warranted. Let's look at that indicator on the chart below.

This five-year chart has the S&P 500 in black and the cumulative advance/decline line in red. In order to construct this line, we simply take the previous week's reading, add the number of stocks advancing for this week and then subtract the number of stocks declining for this week.

As you can see, the advance/decline line has tracked along with the S&P 500 perfectly. Each new recovery high in the S&P 500 has been matched by a new high in the advance/decline line. In fact, there have been some positive divergences in this indicator where the advance/decline line has led the market average higher. So the action of this indicator just confirms that a positive market outlook still seems appropriate.

Click here for larger image.

Source: TheAstuteInvestor.com

My intermediate-term indicators (two- to six-month time frame) did weaken last week as the market ended essentially flat. The indicator I featured last week, the CBOE Equity Put/Call Ratio, declined to neutral territory, so I now have one indicator very bullish and two indicators neutral. This translates into a target cash position for me of 6%. My actual cash position was 6.4% as of last week's close.

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