This Indicator Says Stocks Should Rise 19% in the Next Year

Small Cap Rebound

Twelve times since 1970, this indicator has flashed. Almost every time, stocks have risen sharply in the ensuing year. Now it’s flashing again.

Reminiscences of a Stock Operator, a not-so-fictional biography of Jesse Livermore that was written by Edwin Lefevre back in the 1920s, remains one of the my favorite books of all time—it’s conversational, with as many investing lessons as any book out there. If you haven’t read it, I highly recommend it, especially if you’re just starting out.

That said, Reminiscences isn’t a how-to book; you won’t find chart explanations or screening techniques. Later in his life, Livermore did, however, publish his own brief book in that genre, dubbed simply How to Trade in Stocks. It’s also a solid read, for what it’s worth.

Besides giving you a couple of titles for your summer reading list, the reason I bring those up today is because of one thing that Livermore talked about in his second book that is so applicable to today—the time element of trading. In the book, he mostly wrote about how things take time to play out, especially things setting up for a big move.

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But I want to touch on another aspect of the time element of investing: That similar occurrences can have vastly different meanings depending on where and when they happen.

Right now, for instance, I’m reading a lot about the “crazy overbought” market. Not only have the indexes made big moves of late (the S&P 500 ramped 15% in just three weeks!), of course, but many internal measurements are at nosebleed levels—at Monday’s close (June 8), for instance, a whopping 95% of NYSE stocks were above their respective 50-day moving averages, one of the largest readings in years. The same was true of Nasdaq stocks and individual indexes (like the S&P 500)!

Such straight-up action does likely mean that some profit taking will occur in the near-term. But bigger picture, does such wild upside action portend bullish or bearish things? The answer depends on where the market is in its overall run.

For instance, take a look at early 2018—in January of that year, the market went bananas, with the indexes rising ever-higher on a bunch of good news (corporate tax cuts) while the internals of the market, while not as strong as today, looked great. But, of course, that move came 15 months after the market really got going in November 2016. The result: A very sharp correction and, a year later, the market was lower than it was then.

The January 2018 top came 15 months after the 90% blastoff indicator flashed in November 2016.

Today, however, the market is obviously in a different stance—it’s two months off a historic crash that, at its lows, saw the S&P dip 35% to three-and-a-half year lows. Again, that doesn’t mean the near-term won’t see some wobbles, but the strength is more likely a bullish factor for the intermediate- to long-term.

And that’s not a total guess on my part. It turns out that, after a huge selloff, the first time that 90% of NYSE stocks rise above their 50-day lines is a rare “blastoff” indicator. It’s only happened 12 other times since 1970, and what followed was almost always bullish—the average max gain in the S&P 500 during the next year was 19.4%, and the average maximum loss from the signal during the next year was less than 2%! (Interestingly, we saw a second reliable and rare breadth-related blastoff indicator flash last week.)

Of course, the 90% Blastoff Indicator is just one measure, and nothing is guaranteed in the market. But the point is that, historically, very strong breadth relatively soon after a big downmove (like the one in February-March) is usually a good thing, not a bad thing.

Earnings Gaps Abound

It’s a similar story when examining individual stocks. Take earnings gaps—big gaps higher tend to be bullish for a stock looking out a few months, while earnings disasters often mean a stock is broken. But again, a lot has to do with where a stock is in its overall run.

For instance, look at Five Below (FIVE), which was a great winner for us in 2017-2018. As you can see here, the stock got going from 50 in September 2017 and had a big run (at least for a retailer) for a couple of months, rallying nearly 50% in just over three months. That did lead to some near-term weakness, but given the stock had just gotten going from years in the doghouse, it was more of a kickoff that led to higher prices.

Fast forward to September 2018, though, a year after the original breakout—FIVE had consolidated for a few weeks, and then begun to rip higher, pushing from 96 to 119 and then gapping up to new highs around 136! Coming after 11 months of advancing, that left the stock vulnerable; it effectively marked a top, with the stock making no progress for the next 16 months before crashing with the market this March.

One Growth Idea: Marvell Technology (MRVL)

The good news today is that many growth stocks have come out of “early-stage” consolidations during the past few weeks, so a lot of the strength we’ve seen since mid-April is likely more blastoff than top-ish. One idea: Marvell Technology (MRVL), which I just wrote up in my Cabot Top Ten Trader advisory this week.

Here’s what I wrote:

“Marvell Technology is a chip stock that’s been around for a while which in recent years has transformed itself into a data infrastructure outfit, with chips that play into a variety of major growth trends like advanced automotive products, data center solutions, enterprise networking, wireless connectivity (including 5G) as well as various storage networking offerings. Business has been so-so for a while, but it looks like the firm’s gradual transition to infrastructure (sped up by acquisitions, including that of Cavium in 2018) is about to pay off in a big way; the shut-in has boosted demand for its cloud data center and 5G products, a trend that should continue even as economies reopen, while chips for ARM servers are another growth driver. The stock is strong today because the Q1 report of a couple of weeks ago easily topped expectations (sales up 5%, earnings up 13%), but far more important is that analysts see that as the first of many quarters of accelerating growth—cloud revenue topped 10% of Marvell’s total for the first time in history (sure to go much higher going forward), with overall networking revenue leaping more than 10% from the prior quarter. Meanwhile, wireless infrastructure benefited from a pickup in 5G demand despite some industry hiccups, with management saying its wares are designed into the latest generation of base stations for multiple suppliers. (“We are still at the very beginning of the industry transition from 4G to 5G and look forward to driving significant revenue growth from this end market” per the CEO.) Throw in optimism about connected auto end markets and Wall Street is excited—analysts see earnings up 44% this year and 48% next as business picks up steam. We think the future is bright.”

As you can see in the chart, the stock just broke out from a long dead period, rallying strongly for three weeks after earnings. Like everything else, MRVL could pull back at any time, but the odds favor this latest strength being the beginning—not the end—of the stock’s upmove.

Michael Cintolo

Your Guide to Winning Growth Stocks

Michael Cintolo is a growth stock and market timing expert. His Cabot Growth Investor, with its legendary Model Portfolio, is recommended for all investors seeking to grow their wealth.

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