They say no one ever rings a bell at a market peak, but yesterday, the stock market rang its own bell of sorts. The downside behavior seen today should be considered strong corroborating evidence that a significant market top is now in place. Let’s take it from the top and a look at the action of some very important technical indicators.

NYSE Advance/Decline Anomalies

To begin with, I will start with the a comparison between the NYSE A/D data as reported by Associated Press (AP) and the NYSE A/D data as gathered by my computer. For those who are not aware, the reported AP Data has dwindled steadily in its utility over the years as the A/D data has become heavily polluted with ETFs (double counting) Preferred Stocks and Bond Funds. The result is that the commonly reported A/D Data is heavily biased by interest-rate sensitive stocks, which are really bond surrogates.

Over the last few years, as interest rates have declined, these stocks have advanced (as bonds have advanced) and thereby putting in a mirage of false strength behind the real A/D data. As a result, technicians looking at just the reported data come to the conclusion that breadth is very strong and—as a result of this data—the market is OK.

In fact, just yesterday, the NYSE AP reported data series caused the Widely Watched A/D Line to move to a new high for the move. In classic technical analysis this is an all clear signal for the stock market as the A/D Line will normally turn down well in advance of a serious stock market decline. However, the data is polluted and skewed to the upside.

This influence can be seen on the chart below, which shows the NYSE Bond Exchange A/D Line during the Stock Bear Market of 2000 to 2002. Note how the Bond A/D Line took off, and rallied throughout the course of the entire stock bear market decline. This is critical for investors to grasp. Note that stripping away the “interest rate sensitive” component in this aggregate data reveals a very different outlook for the stock market.

NYSE Bond Exchange A/D Line
Stock Bear Market 2000 - 2003

In my work, I have garnered a substantial list of NYSE Operating Companies approaching 1200 operating companies. To be sure, this list would embody the entirety of the S&P 500 plus, plus, plus. Deducting these operating companies from the reported data leaves two “remainder” columns: one of advancing issues and the other of declining issues.

These issues include Bond Funds, Country Funds, ETFs, Structured Products, Preferred Stocks and a collective “bouillabaisse” soup of other “stocks,” which in many cases have little or no correlation to the U.S. Stock Market.

Yet, if I plot the “remainder” issues A/D Line versus the NYSE Bond A/D Line, there is a reasonable correlation. Who knows? Maybe the balance of the list comes from the proliferation of stock fund and ETFs, which in essence incorporates “double counting” into the AP A/D statistics?

NYSE Bond A/D Line vs. Barbera's Remainder Issues A/D Line
October 1997 - September 2005

Removing the Bias Reveals the Truth

In any event, there is a huge upward bias in the reported numbers, which when stripped away as I said earlier, reveals a portrait of a much weaker stock market than most would expect. How weak? The Answer: Very Weak. Over the last few weeks, the S&P 500 has hovered near four-year highs, yet over the same period of time, my Operating Company Only A/D Line has been moving lower and has actually undercut its 200-day moving average. Yesterday, as the S&P 500 came within 3.56 S&P points of a new closing high, my Operating Companies Only A/D Line ended just barely back above the 200-day moving average.

S & P 500 vs. Barbera Operating Companies Only A/C Line
May 1, 2004 - September 12, 2005

Since the end of last year, the S&P 500 has posted two higher highs in March and July with readings of 12/30/04 1213.56, 3/07/05 1225.30 and 07/28/05 1243.70. Over the same period of time, my Operating Companies Only A/D Line has made a pattern of flat highs with readings of 12/30/04 10,077, 03/07/05 10,092, 07/28/05 10,177.

Last Friday, with the S&P 500 at 1241.48, my index closed at 9,306. Note the deterioration. What’s worse, over the last few days, as the S&P 500 has closely approached its highs for the year within just 4 S&P points, the A/D Oscillators based on the Operating Company Only data are acting just horribly. “Red Alert–Mr. Scott !!!” Yesterday the 20-day Moving Average of Advances minus Declines (an Oscillator) closed below zero, even as the S&P 500 came with 4 points of a new 4 year high!

S & P 500 vs. 20-Day Oscillator of Operating Companies A/D Line
January 1, 2003 - September 12, 2005

This is a remarkable event, which is rarely seen and is nearly always a sign of market about to undergo a serious and sustained decline.

A Look Back to the Past

Back in March 2000, we saw the S&P 500 close at a new all time high of 1527.35 on March 23, 2000 with the 20-day A/D Oscillator below zero at a reading of –51.20. At that time, this was a sure sign of deteriorating breadth. From that point forward, the S&P 500 began a relentless decline, which ultimately approached 50%. March 23, 2000 was not a good time to be buying common stocks.

Nor was July 11, 1990. Back then, the S&P 500 closed at 361.22, within 6 points of its former high seen on June 4, 1990 at 367.39. Yet with the S&P 500 within 2% of a new all-time high, the 20-day A/D Oscillator closed at a reading of -20.48. Two days later, the S&P 500 matched a new all-time high on July 13, 1990 with a close of 367.31 The 20-day A/D Oscillator was at a reading of +14.67, just barely above zero!

The result, within 27 days, the S&P was down 16.34% from that July 1990 peak and down nearly 20% within 2 months. July 1990 was also not a good time to be purchasing common stocks.

S & P 500 vs. 20-Day Oscillator of Operating Companies A/D Line
October 1998 - March 23, 2000

March 2005: The S&P at an all time high with the 20 day A/D Oscillator below zero = Huge Warning!

S & P 500 vs. 20-Day Oscillator of Operating Companies A/D Line
September 1989 - April 1991

July 1990: The S&P very close to an all time high with the A/D Oscillator below zero = Huge Warning!

Is The Stock Market in BIG Trouble?

What About 1973?
Still wondering whether the stock market is in big trouble? OK. Let’s take another trip down memory lane to 1973—anyone remember January 1973? It was a good time for investors as the market was up several years in a row. Investors Intelligence showed record levels of optimism, the specter of Vietnam was receding and no one expected problems in the equity market.

On January 11, 1973, the S&P  500 closed at a new all-time high of 120.24 and joined with the DJIA closing above 1,000. At the same time, the 20-day Oscillator of Advance less Declines closed below zero, at a reading of -98.52. From there, the long agonizing bear market decline of 1973-1974 began with neither the Dow or S&P 500 exceeding the January 1973 high for nearly 10 years! Between 1973 and 1974, the S&P 500 tumbled a whopping 49.57%. A similar decline today would take the DJIA below 5,400.

S & P 500 vs. 20-Day Oscillator of Operating Companies A/D Line
October 1971 - October 1974

Above: The January 1973 stock market peak, which preceded a 50% decline in 1973-74 was delineated by a new high in the indices accompanied by an A/D Oscillator value below zero. On a slightly smaller scale, nearly the same circumstances prevailed over the last few market days.

What about 1987?
Was there a similar signal in 1987? The answer is there was a similar signal in a manner of speaking. During 1987, the A/D Oscillator recorded series of lower highs, following the peak reading, which was seen very early in the year on January 28, 1987 with a value of +331.06. At the time, the S&P 500 closed at 275.31. From there, the S&P 500 then recorded a higher high in on June 19 at 305.65, with the first lower high on the A/D Oscillator at +204. By August, breadth had been thinning down and participation in the rally was flagging. By the August 20th high, the S&P 500 had pressed forward to 335.89, but by then the A/D Oscillator was recording its third lower high at +119.5.

S & P 500 vs. 20-Day Oscillator of Operating Companies A/D Line
October 1987 - May 1988

Above: the 1987 experience with the S&P 500.

From the August peak, the S&P 500 then experienced a sharp decline followed by a secondary “failing rally,” which peaked at a lower reading of 328.08 on October 5, 1987. This reading was 8.69 index points below the absolute high in that time period, which had been seen on 8/25/87 at 336.77. However, as the S&P 500 recorded this slightly lower secondary high on 10/5/87, the A/D Oscillator was below zero with a reading of –46.72 AND other averages were still very close to new all-time highs.

For example, as can be seen on the chart below, if we look at the NASDAQ in 1987 against the same A/D Oscillator, it can be seen that on October 5, 1987 the NASDAQ Composite closed at 453.63 within 1.65 index points of its August 26th peak at 455.28. At the time, other secondary market indices—such as the Value Line Arithmetic and the Russell 2000—had also come within a fraction of a full match of their respective August 1987 all time highs.

Thus, while a rotation had taken place into smaller cap names, on balance in early October 1987, we saw several major U.S. Stock Market Indices closely approaching new all-time highs. We also saw the A/D Oscillator below zero and the S&P 500 within 2.6% of its all-time high with the same extreme deterioration taking place.

NASDAQ Composite Index vs. 20-Day Oscillator of Operating Companies A/D Line
September 1987 - April 1988

Above:  The NASDAQ in 1987 with a double top matching peak in October 1987 versus the earlier high in August 1987. As the NASDAQ, Value Line and Russell Indices Double Topped, the A/D Oscillator was below zero warning of a weak stock market “internal” condition.

NYSE Composite Index vs. 20-Day Oscillator of Operating Companies A/D Line
September 1998 - September 2005

Back to the Present

Getting back to the present day, it could be argued that with the NYSE Composite Index moving to new all-time highs over the last few days, the same type of very bearish sell signal has been registered. The chart above clearly shows the 20-day A/D Oscillator (of Operating Companies) below zero.

In my view, even if the NYSE Composite had not gone to new all time highs, the very fact that the S&P, NASDAQ and Russell Indices are within a few points of matching a nearly 4-year high with this indicator below zero tells me this is a market headed for big trouble—and sooner rather than later.

I remind readers that in addition to the very bearish technical action discussed above, there is also a very long dated “Time Span” in effect for the S&P 500, which has not tagged its lower 200-day trading band in 735 trading days, the fifth longest such streak seen since 1950. The implication of the “Time Span” analysis strongly suggests the S&P 500 is overdue to reverse course and move down and tag the lower 200-day band at 1152, which is more than 6% below current levels. Over the medium-term horizon, I continue to believe the S&P 500 is forming a major top in this area and could decline fairly rapidly toward the 1065 to 1100 zone in coming months.