The news remains tilted to the negative side. But the drumbeat is picking up along Wall Street analysts that at least some sort of tradable bottom is approaching. And the action in the stock market over the last few days reflects this viewpoint, although it’s not certain whether this rally will last or fizzle. We were faked out before this year, by a summer rally that collapsed in September.

There is, however, a chance that this rally, or perhaps a subsequent rally somewhere down the road, may mark either the end of the bear market or at least an intermediate term reprieve.

I recently wrote on the subject based on the historical premises of the Presidential Cycle. According to a recent Deutsche Bank (NYSE: DB) post: the S&P 500 has “always” been higher one year after the midterm election. Others, including well known Wall Street economist Ed Yardeni, have recently suggested that the years which follow a midterm election tend to be bullish.

WATCH THIS VIDEO: Sustainable Rally or…Another False Hope?

Finally, even though it’s not quite Halloween yet, the stock market often rallies between the months of November and January, a period of time which includes the Santa Claus rally and the January effect.

In this article, I won’t bore you with the statistics of how reliable these seasonal and cyclic events are. Instead, I will delve into what the stock market is actually telling us via a review of a key price chart.

The Market’s Breadth

When measuring the market’s breadth, we’re interested in seeing how many stocks are advancing and how many stocks are declining. We map this out in an ongoing graphic known as the New York Stock Exchange Advance-Decline line (NYAD).

The reason breadth is useful is that it’s not a metric that can be distorted. Whereby major indexes can be skewed by the action in heavily weighted stocks such as Microsoft (NSDQ: MSFT) and Alphabet (NSDQ: GOOGL), both of whose recent earnings misses took heavy tolls on the S&P 500 (SPX) and the NASDAQ 100 (NDX) indices, on the same day, NYAD actually climbed as other stocks in the market were rising despite the misfortunes of the tech giants.

Thus, when NYAD rises, it’s a bullish trend, as more stocks are advancing than declining. A falling NYAD line is bearish for the opposite reason. I like to think of the NYAD’s trend in terms of the odds of picking winners. When it’s going up, my odds of success are higher.

It’s useful to pair NYAD with a major stock index such as the SPX. The market’s trend is consistent when both SPX and NYAD trend in a similar direction. More importantly, we like to see a new high in either measure confirmed by the other. That’s a sign that the market is operating at its highest level of efficiency.

On the other hand, when we see divergences between SPX and NYAD, such as a new high in SPX without confirmation from NYAD, we start to wonder if a change in the trend is near. Even better is the reverse. When SPX, for example, makes a new low and NYAD does not, it often signals that the downtrend is about to reverse (a market bottom).

Moreover, if NYAD persistently rises when the indexes are flat or lower, it’s usually a bullish sign.

The Big Picture

Over the years, I’ve learned that NYAD is more useful when I add traditional technical analysis indicators to the price chart, which essentially turns the line into an index-like instrument. This is also very helpful because although indexes can be skewed due to large moves in big market capitalization stocks, such as Amazon (NSDQ: AMZ), in NYAD one stock’s performance, up or down, counts just once. This gives us a true picture of what’s happening under the hood.

I add the 200-day moving average (black line in middle of chart) along with an indicator known as the Bollinger Bands (BB, Red lines above and below NYAD). These indicators let me known when a particular trend has gone too far.

Here’s how it works. The 200-day moving average is a measure of the long term mean (average performance) of NYAD.

The 200-day moving average serves as a support or a resistance level. A move above the 200-day is a sign that the market remains strong. A break below this line signals increasing weakness.

The upper and lower Bollinger Bands measure two standard deviations above and below the 200-day moving average.

What’s most important to understand is that when NYAD rises above the upper BB, or falls below the lower BB, the trend has gone too far. A rise above the upper BB usually marks a market top and a reversal to the down side. A fall below the lower BB often marks an important market bottom.

Another useful indicator is the Relative Strength Index (RSI), which measures when a market is oversold or overbought. When RSI rises above 70, it signals an overbought condition and a possible price reversal. An RSI reading below 30 signals the opposite.

Past Performance

In the chart below, I show the NYAD along with this cadre of indicators over the last three years. And here’s what it says during a market rally:

• There were 10 instances in which NYAD rose above the upper Bollinger Band in this period. Each resulted in a pullback. One pullback, in late 2019-early 2020, was significant (the COVID bear market).
• The others were not, as the Federal Reserve kept lowering interest rates, in turn boosting stocks.
• In March-April 2020, the 200-day moving average held as support and stocks rallied, again boosted by the Fed.
• NYAD topped out in late 2020 without breaking above the upper Bollinger Band, but nearly touched it before the bear market fully developed.

On the down side:

• NYAD has broken below the lower Bollinger Band three times since the 2021 top;
• Each breach of the lower BB has delivered a rebound;
• The massive summer 2022 rally was preceded by a breach of the lower band;
• The summer rally of 2022 failed at the 200 day moving average; and
• NYAD has recently broken below the lower band and has once again bounced.

Where We Are Today

The recent action in NYAD suggests that some sort of bottoming process is developing. I’m basing this on the following facts:

• NYAD has recently been outside the lower Bollinger Band and has rebounded aggressively;
• RSI has recently hit a very oversold level which preceded the move below the lower Bollinger Band;
• We are closing in a bullish seasonal period; and
• The Federal Reserve is rumored to be nearing a slowing in its rate of interest rate increases.

Bottom Line

The market is very oversold. A great deal of bad news has already been priced in.

A host of bullish precedents, cyclical, seasonal, and technical are converging. There are rumors that the Federal Reserve may slow down the pace of its interest rate increases.

The NYAD is responding positively, with a bullish initial response to these factors in the last few days. All of which adds up to the possibility that any further bullish surprise(s) could spur stock prices higher.

Of course, in the current world, anything is possible, which is why any historical precedent, even the one I’ve just described, may not hold up. The current upside reversal could fizzle out at any moment.

While it may not be time to go full bore bullish in one’s margin trading account, I wouldn’t recommend spending too much time away from the trading screen these days. Events and a potentially bullish market response could develop and expand rapidly.

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