Thursday, October 8, 2015

Bingo! We have a buy signal!

In my weekend post, I highlighted a possible setup for a Zweig Breadth Thrust buy signal (see Sell in May, ______ in October). The Zweig Breadth Thrust is an extremely rare buy signal that generally signals the start of a new bull market (see A possible, but rare bull market signal).

Steven Achelis at Metastock explained the indicator this way (emphasis added):
A "Breadth Thrust" occurs when, during a 10-day period, the Breadth Thrust indicator rises from below 40% to above 61.5%. A "Thrust" indicates that the stock market has rapidly changed from an oversold condition to one of strength, but has not yet become overbought.

According to Dr. Zweig, there have only been fourteen Breadth Thrusts since 1945. The average gain following these fourteen Thrusts was 24.6% in an average time-frame of eleven months. Dr. Zweig also points out that most bull markets begin with a Breadth Thrust.
As of the close today (Thursday October 8, 2015), we have another ZBT buy signal.

Learning from 2009
The last ZBT that I can find occurred at the market bottom in March 2009.

While history doesn't always repeat itself exactly, I can see a number of similarities that may give usa road map to how the market is likely to behave in the next few months. Here is what happened in 2009:

We can observe that breadth was improving when the market bottomed in March 2009. A ZBT is a powerful exhibition of buying momentum and RSI(5) has not unexpectedly flashed an overbought reading. Right after the signal, the market weakened and pulled back for two days and continued upwards, showing a series of "good" overbought readings as it advanced.

Today, we can observe similar conditions. Breadth measures have improved since the "bottom" last week, though the low last week did not exactly test the August panic lows.

The market has also become overbought on RSI(5). These series of charts from IndexIndicators (with my own estimate shown as a dot) also shows how overbought the market is on a 1-3 day time horizon:

...and longer term indicators with a 1-2 week time horizon, based on a net 20 day highs-lows measure. I would remind you, however, that overbought conditions can stay overbought (see the reference to "good" overbought readings above) and the market got off the charts oversold in the way down in August.

We see similar readings on an intermediate term 1-2 week basis using the average 14-day RSI indicator as well:

A powerful "buy" signal
If history is any guide, the Zweig Breadth Thrust is signaling that stocks are about to embark on another upleg. While the market is very overbought and I have no idea of what might happen in the next few days given the volatility seen during Earnings Season, these conditions are highly suggestive that downside risk is extremely limited and stocks will be significantly higher by year-end.


Mike Gilmore said...

Thanks for this. Looking at the chart from 2008/09, got me thinking. QE1 ($600 billion for mostly MBS purchases) was announced Nov 25 2008. Markets didn't really react.

An announcement that QE1 was expanding to $1.25 trillion for MBS purchase and $300 billion for Treasuries occurred Mar 18 2009. If you look at the May 29 2009 graph above, you can see equities really began to launch in early March (wonder who had advance knowledge the expanded QE was coming? Anyone...? Bueller...?), and continued to climb.

In our current environment, we don't have an official QE(n) at the moment. What effect will this have on the current ZBT buy signal? Also, in 2009, IIRC, we had rising profit expectations. Now, we seem to be experiencing falling profit expectations and corps are lowering forward guidance. How will this affect the ZBT buy signal?

Will be curious to see what happens!

Joseph said...

Thank you for the article.

Perhaps it might be feasible to wait for some form of minor daily dips to add up long?


greenlander said...

This buy signal is a bit late, no? The meat of this leg up is probably already over not to say that we don't have a chance to go much higher. But risk is increasing for longs now that we are heading into pretty strong resistance in SPY around 205-206ish

GlobalDan said...

Thanks for the post. Also wondering how valuations play into this? They were low in March 2009 but are nose-bleed high today

Sam said...

Of the 14 Zweig thrusts since '45, how many had positive gains over the next 12 months?