Ned Davis: Four Indicators to Know When to Sell

By on August 8, 2009

Mark Hulbert, writing for Marketwatch, has exposed four indicators that Ned Davis looks for to know when to start selling into what he believes is now a cyclical bull market.

  • Valuation. Davis would look to exit from stocks whenever the P/E ratio on the S&P 500’s normalized earnings reaches 20. To be sure, putting this indicator into practice is a bit tricky, since it requires normalizing those earnings — adjusting them, in other words, for where we are in the economic cycle. Nevertheless, Davis calculates that normalized earnings on the S&P 500 currently stand at “around $60,” which suggests that Davis will be looking to start exiting the market at the 1,200 level.
  • Sentiment. Davis maintains his own sentiment index, which he calls his “Crowd Sentiment Poll.” This index currently stands at 62%, according to Davis, which is just above the 61.5% level that he considers to be the lower bound of “extreme optimism.” He says that, on past occasions when this index has risen above 61.5%, its eventual peak has averaged 68%. He says that reaching that level this time around would “be a sign for traders to begin selling weak performers.”
  • Internal market divergences. The indicator that Davis relies on here is one that was created three decades ago by Norman Fosback, who currently edits a newsletter called Fosback’s Fund Forecaster. The indicator is called the “High Low Logic Index,” which represents the lesser of new 52-week highs or new 52-week lows as a percentage of all issues traded. In Fosback’s book “Stock Market Logic,” he describes this indicator’s rationale as follows: “Under normal conditions, either a substantial number of stocks establish new annual highs or a large number set new lows — but not both. As the [High Low] Logic Index is the lesser of the two percentages, high readings are therefore difficult to achieve. … When the Index attains a high level, it indicates that the market is undergoing a period of extreme divergence. … Such divergence is not usually conducive to future rising stock prices.” Fortunately for the current market, this index is solidly in bullish territory right now at 0.8%, according to Davis’ calculations. He says that it would have to rise to around 2.5% before he would start looking for the exit signs.
  • Rising interest rates. Davis has found from his research that one of the best market timing indicators in recent years has been the 26-week rate of change for investment-grade bond yields. With that rate of change currently standing at minus 12.6%, a sell signal from this indicator is not imminent.

Of the four indicators, sentiment is the only one close to what would cause Davis to begin dumping his stocks.



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