After The Pullback, Should You Buy?

After we get a pullback, is it still okay to buy? Long-time readers will undoubtedly recall our discussions of breadth surges and the long-term buy signals associated with such an event. The idea is that when the breadth of the market surges to the upside and advancing issues swamp decliners over a 10-day period, the resulting overbought condition is actually healthy and not something to be feared. As we’ve detailed in the past, history shows that such surges in breadth lead to solid advances over the next one, three, six, and twelve month periods.

So, why bring this up now? Didn’t these signals already occur? The answer is yes; we did get breadth surge buy signals in late March of this year. And in keeping with history, the market’s ensuing climb actually exceeded the average gains projected over the next three months.

But without further ado, the point is that the blast from the July low has triggered another round of breadth surge buy signals from a wide variety of indicators. And cutting to the chase, this means that the outlook for the stock market going forward definitely favors the bull camp.

While the numbers are indeed impressive, as they say, there are three kinds of lies; lies, damned lies, and statistics. So, since average returns can be misleading, we should also point out that such signals are not always profitable. For example, the market has been higher one month after this signal 25 out of 30 times (83.3%). Three months later, the market was up 24 out of 30 times (80%). Six months later, the market was up 26 out of 29 times (89.7%). And one year later, the market was up 27 out of 28 times. Thus, one year later, stocks have been higher after our breadth surge signal 96.4% of the time. (For those curious types, the one 12-month “loser” signal occurred on 1/13/87 – the “Crash” put an end to that run!) 

So, armed with fresh buy signals from indicators that have been fairly reliable in the past, it would seem to be a good time to simply load the boat and relax. However, the success of such a plan would depend entirely on your time horizon, as many members already know we talk about constantly.

For the trader types out there looking out over the next week or two; we can’t help but counsel caution in terms of new buying. While stocks could certainly head higher, the odds of a run-of-the-mill pullback of -3% to -5% would seem to be increasing with each passing day. And last week’s action in the NASDAQ is certainly worth watching from a short-term perspective. Thus, our game plan is to continue to sell options far away from the market and collect premiums all the way up!