A strong bull market can make secondary indicators either unreliable or ill-timed.
[ibd-display-video id=2382612 width=50 float=left autostart=true]This is important for IBD-style investors to remember because the IBD investor is a market timer. History provides many examples of the market itself (the primary indicator) successfully contradicting a secondary indicator. The Reagan era had some classic examples of the bulls trampling bearish signals.
The Reagan rally of late 1984 to February 1985 was sharp and brief. Most of the gains came while Investors Intelligence’s bullish percentage was above 60% – well above the 55% level that Investors Intelligence calls “the danger zone.” (The indicator is counterintuitive: A high bullish percentage is signaling a possible market correction.)
An individual investor who sold when the bulls-bears ratio hit 60% would’ve missed the rally, which involved a 21.8% gain over about nine weeks.
Recently, the bullish percentage has been above 60% for multiple weeks. On Wednesday, it reached 66.7%, the highest level since April 1986. (Track it in the Psychological Market Indicators section , found under “Market Trend” at the home page of Investors.com.) Now keep in mind that neither Investors Intelligence nor IBD would recommend a move to the sidelines based on this indicator alone.
A market top often takes months to form. For example, in the Reagan rally mentioned above, the top was formed from February 1985 to July 1985. The distribution days on the daily chart would’ve had IBD-style investors raising cash well before the choppy five-month top was completed.
But what we’re most concerned with here is the warning signals as the rally advanced.
In December 1984, the bullish percentage was in the so-called danger zone of 55% or higher. In all of January and half of February, the percentage fluctuated from 55.8% to 66.1%.
Yet, this was precisely when the rally rose nine weeks in a row, scoring weekly percentage gains of 0.04% (as it bottomed) and then, 2.2%, 0.7%, 0.04% (pausing in a narrow range), 2.4%, 4.3%, 4.2%, 1.6% and 3.6%.
Also, consider this item: The historically high reading for the bulls – since 1982 in Investors Intelligence’s bulls vs. bears gauge – came on April 4, 1986. That day the Nasdaq closed at 372.23.
What happened next? The Nasdaq rose 10.5% to 411.33 in three months, not great but not a bad rally.
After the peak, the Nasdaq then corrected almost 17% over two and a half months. This 1986 rally and pullback may hold the key on how to put the bulls vs. bears indicator to good use. High bullish numbers can point to a market correction, but the timing is seldom immediate.
So, when looking at the current market, be aware of this possibility: The market might correct soon, but it also could have an additional run-up before the pullback comes.
The disciplined investor should monitor the major indexes. It is there that investors will get their most timely read on the market.
( A version of this column was first published on March 10, 2017. Follow Whitfield on Twitter at @IBD_PWhitfield. )
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