Thoughts from last week's Technician segment with Lowry Research's Richard Dickson, which you can listen to in full at Financial Sense Newshour here or on iTunes here.
Richard Dickson, Senior Market Strategist at Lowry Research, the oldest technical investment advisory firm in the country, claims we are in the latter stages of the current bull market and that a major peak in stocks could be seen in 4-6 months.
In his recent interview with Financial Sense, Dickson says when the broader indexes are approaching a top the advance is led by fewer and fewer stocks, which has been seen at every major market peak they've studied.
This phenomenon registers in the market’s widely followed advance-decline line, however Dickson points out that relative under-performance by small cap stocks often provides an earlier warning signal to potential trouble ahead. He notes that small cap stocks began to deteriorate almost a year ago and many have already entered bear market territory. This is not healthy action, he says.
Regarding the advance-decline line, Dickson makes a distinction between Lowry’s Operating Companies Only (OCO) line and the more common metric published by the New York Stock Exchange; the former eliminates preferred stocks and other issues that contribute to noise in the latter. He points to July 21 as a confirmed divergence, where new highs in the S&P 500 failed to see a new high in the OCO advance-decline line. Based on research conducted at Lowry, this predicts a market top within 4 to 6 months. In the interim, Dickson will be watching a variety of other technical indicators for confirmation, such as buying power and selling pressure.
Financial Sense asked Dickson about the motivation behind a widely-cited research paper published by Lowry called “An Exploration of the Nature of Bull Market Tops.” Dickson explains that the study of market tops began with Paul Desmond, the principal at Lowry Research, who was fascinated with the 1929 market high. While sorting through data going back to 1925, Desmond noticed that the final high in the Dow that fateful year only featured a small number of stocks also making new highs, and he sought to understand whether this was random or followed a regular pattern. This interest led to Lowry’s theories regarding selectivity, where only a small number of select blue chip stocks participate at market tops.
So what causes this lack of participation? Dickson posits that this is likely due to the perceived valuation of individual stocks and subsequent profit taking by market participants. He points out that waiting for the final top of an index, such as the S&P 500, can cause investors serious pain, since a good number of equities in their portfolio may already be down substantially. It’s also partly the structure of market-cap-weighted stock indexes that leads to this deceiving picture of strength, where you see a few large, popular stocks leading the push higher – “2000 was the poster child for that kind of action,” he says. “You had a handful of dot-com stocks that were driving the S&P 500 and Dow to new highs. You had similar action back in 1972 when you had the so-called Nifty 50...driving the market to a new high.”
When questioned about the influence of exchange-traded funds and index investing on market dynamics, Dickson admits that passive investors may not be concerned by the deterioration underlying the market. These investors are simply looking to get out near the top. But for those looking to outperform the broader indexes, it pays to focus on stocks that continue to perform well while the laggards drop off.
“If you’re invested in the SPY, hang on. You’re not at a top yet,” he advises. “But if you’re invested in a portfolio of individual stocks, you should be examining that portfolio very closely for the stocks that are now starting to underperform and get rid of them. The choice is yours whether you want to reinvest that money into the strongest stocks in your portfolio, or find other stocks that are strong performers, or keep that money in cash.”
Financial Sense asked Dickson what could make him change his outlook regarding the market topping in the next 4 to 6 months. Dickson points out that the market doesn’t deal in certainties but in probabilities. While he admits that anything is possible, he stresses that it’s already one of the longest bull markets in history and, given the level of selectivity we see today, Lowry believes the likely outcome is for a top later this year or early next.
Listen to this full interview with Richard Dickson, Senior Market Strategist at Lowry Research, by clicking here. For a complete archive of our broadcasts and podcast interviews on finance, economics, and the market, visit our Newshour page here or iTunes page here. Subscribe to our weekly premium podcast by clicking here.
