Market Insights: Underlying strength in the market

Underlying strength

With the Brexit vote coming up next week, there is a feeling of nervousness in the markets as we have seen the CBOE Volatility Index spike up 50% in the second week of June.  In times of uncertainty, it can sometimes be beneficial to look at what the stock market is telling us.  In this sense, we are not referring solely to the Dow Jones Industrial Average (DJIA) price level, but rather the breadth of the market.  There is an indicator called the cumulative Advance-Decline (AD) Line that is based on Net Advances, which is the number of advancing stocks less the number of declining stocks.  The AD Line is a cumulative measure of these Net Advances.  It rises when Net Advances is positive and falls when it is negative.

Technical analysts use this indicator to gauge bullish or bearish divergences in the market.  In general, these divergences can signal a change in participation and foreshadow a reversal in the trend of the average (in this case the DJIA).  As a general rule, when the underlying indicators (breadth) are strong relative to the averages, it is a bullish signal for the market.  

The following chart shows the AD Line of the New York Stock Exchange (NYSE) against the DJIA over the past eighteen months.  The strength of this measure of market breadth is quite remarkable, especially when you consider the level of prevailing negative sentiment which we discussed here.

                                                  Source:  The Berge Report

While there are no guarantees to be had when considering any single indicator, this positive breadth definitely signals to us that the market wants to push to new highs.  The upcoming Brexit vote could have a negative impact in the short-term if the vote is to leave; however, we believe this indicator will likely prevail and we may see new highs in the next quarter.