These Two Indicators Say the ‘Trump Rally’ in Stocks Can Continue for Months

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Full steam ahead: The average stock and interest-rate-sensitive shares have kept pace with blue-chip averages like the Dow Jones Industrials and the S&P 500, pointing to underlying strength in the equity market.

A surprise could be in store.

That’s right. Don’t be caught off guard if the stock market extends its gains, even as some are calling for an end to the so-called Trump rally.

While a short-term decline of up to 5% is always a possibility during a bull market, the prospect of the major averages stopping dead in their tracks and reversing for good is faint.

This view is based on the things that count. To wit: historical precedent, not personal opinion.

And there is plenty of precedent to show that most bull markets are nearing the end when these two developments occur: 1. The average stock can no longer match the highs set by the Dow Jones Industrial Average or the S&P 500 Index; and 2. Interest-rate-sensitive issues diverge from the higher highs posted by the Dow Industrials or the S&P 500.

The best gauge of the average stock may be the daily New York Stock Exchange advance-decline, or A-D, line. Historically, when the A-D line is unable to confirm new highs in the blue-chip averages for at least several months, it is usually a sign that the market’s foundation is unstable.

This is especially true in a mature bull market when the central bank is tightening the money supply and short-term rates are rising.

As the chart below shows, the recent high in the S&P 500 was confirmed by a high in the A-D line. This means the broad market is in gear with the blue-chip indices. Thus, stocks have essentially bought themselves some time before an inevitable rotation into larger companies renders the A-D line unable to keep pace with the S&P 500. This would start a period of divergence between the two yardsticks that would ultimately lead to a bear market.

©TradeStation Technologies, 2001-2016

The other reliable long-term signpost of market direction, interest-rate-sensitive issues, has outperformed the S&P 500 since the summer. The chart below shows the NYSE Financial Index  keeping pace with the recent S&P 500 highs. Long-term market tops rarely occur when interest-rate-sensitive groups like the banks and brokers are at bull-market highs.

©TradeStation Technologies, 2001-2016

As for the action of leading stocks, many are taking a break after having advanced in tandem with the averages. For active investors, now would be the time to make a list of issues forming bases or sideways consolidation patterns on their charts.

Glaukos Corp. is one such stock. Its chart pattern shows a base of three months being formed. In fact, this base is as constructive as any in the market, at least among those with reasonable liquidity.

Glaukos is a specialist in glaucoma treatments. After posting losses for 2013 through 2015, most analysts on Wall Street expect a return to profitability in 2016 followed by an estimated 83% growth in earnings for 2017. Revenue growth has been impressive, both in magnitude and stability. For example, the past six quarters have seen the top line grow between 44% and 60%.

After coming public a year and a half ago at $18, GKOS built a year-long consolidation pattern. As seen on the chart below, its most recent breakout attempt last fall failed amid softness in the broader market. On a bullish note, the stock is under extreme accumulation (high-volume buying) over the past six weeks. This occurs as price forms the right side of its cup-like pattern.

Aggressive speculators might consider using the $39.82 high of Sept. 23 (the base top) as a trigger for an entrance. As always, a protective stop should be used to mitigate risk, along with a starter position that is half, or less, the normal size. In most cases, a position should not be entered when price is extended, i.e. more than 5% past the top of its base for buys.

©2016 MarketSmith Incorporated

The market may just surprise most investors by adding to its gains in the months ahead. For those who rely on historical precedent, not a crystal ball, this view is buttressed by the message given by the two reliable long-term signposts I mentioned. The average stock and interest-rate-sensitive issues have kept pace with large, blue-chip averages like the Dow Jones Industrials and the S&P 500.

This buys the market some time before the usual period of decay in these two measures leads to a bear market.