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Don't have the charts open right now but if my memory is correct, the daily
AD line signaled a top in 1966. The broad market in fact did top, however
the S&P 500 did not top out until 1968. This was merely an indication that
the Nifty Fifty high growth stocks were getting the bulk of the money and
benefiting from PE ratios which rose to the moon. When the PE's got to the
point where they could expand no more and the monetary environment became
less friendly, the bottom fell out of the market for some 10 years. Just
because the AD divergences persist for an extended period of time before
prices confirm, does not mean that AD information has lost its value. In
fact, doesn't look to me like a whole lot has changed.
Earl
-----Original Message-----
From: BruceB <bruceb@xxxxxxxxxxxxx>
To: RealTraders Discussion Group <realtraders@xxxxxxxxxxxxxx>
Date: Thursday, February 11, 1999 5:04 PM
Subject: Re: Re[2]: GEN: TC2000 A/D Line Revisited
>I think the AD line is slowly but surely becoming a useless indicator for
>finding market tops. I say this for three reasons, which can be seen by
>comparing the S&P to the Russell 2000 (R2K).
>
>1. More and more people are finally seeing the light and realizing the
vast
>majority of mutual fund managers can't even match the S&P (let alone
surpass
>it...). They are therefore putting more of their investment dollars into
>S&P index funds. This causes two problems. A lot of people think the R2K
>is composed of the 2,000 largest companies, it isn't. It is actually
>comprised of the 2,000 next largest companies after the biggest 1,000 are
>removed. What this means is there is zero overlap between the R2k and the
>S&P. Therefore, any money going into S&P index funds is precluded from
>going into R2K stocks. Furthermore, the S&P is market cap weighted, which
>means the majority of money flowing into S&P index funds goes into just a
>handful of the biggest stocks. This just causes the big to get even
bigger.
>
>2. There is an inherent bias against the R2K. One of the darlings of the
>S&P over the last two years has been Cisco. Over those same two years
Cisco
>has purchased 13 small but very promising companies, many of which were
>trading on the R2K at the time. It's entirely possible that all 13 of
these
>companies would have appreciated significantly in value, and helped to
carry
>the R2K index to new highs, but now we'll never know because they're now a
>part of Cisco. That's also 13 companies that would have helped to push the
>A/D line higher, but now can't. The point is, the "good" companies within
>the R2K get bought out, leaving more and more "bad" companies within the
>index. This bias has always existed, but it has certainly been greatly
>enhanced over the past 2 years, because large companies have been using
>their appreciated stock more and more to make acquisitions. Since this
>buying spree by the large caps shows no sign of slowing down, this negative
>bias against the R2K and the A/D line will continue.
>
>3. In addition to the negative effect of the S&P index funds on the A/D
>line already mentioned, the actively managed funds are also making the
>problems worse. On the surface, you would think that the fact that so much
>money is going into the largest 500 companies through the index funds would
>give the managed funds a field day with smaller but promising companies,
but
>it doesn't. Although the percentage of money going into index funds has
>gone up, in absolute terms the size of managed funds has gone up as well.
>The problem this has created is that there is simply no way a fund the size
>of Fidelity Magellan can take positions in small caps without getting
killed
>on the slippage when both buying and selling the stock. Any advantage in
>buying these "undervalued" stocks would disappear on the transaction.
>There's simply too much money being moved in and out. This means even the
>managed funds have an inherent bias towards making the big bigger and the
>small smaller as well.
>
>I think the classic Dow theory analysis of transports vs industrials still
>carries some weight (because most of the transport stocks are pretty
large).
>Since the transports have not made a new high while the industrials have,
it
>does raise some concern. However, unless I'm doing my math wrong, the
>transports and the industrials have gone up almost the exact same amount in
>percentage terms since their October lows (the transports just dropped more
>in the first place). When you take that into account, the divergence
>doesn't look so dangerous.
>
>Bruce
>
>
>
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