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Market Lab Report
I find this highly unusual and almost unprecedented. Why is the market moving higher while the RS line of the IBD 85-85 index moving lower?

Q: I often check the RS line of the IBD 85-85 index to see how leading stocks are trading against the broad indexes. The RS line of the 85-85 index has been falling since May 2012, which I find to be somewhat out of the ordinary in a time where the Nasdaq had outperformed the S&P and Dow.

It is not out of the ordinary to see the 85-85 index underperform during a bear market, but not often do you see it underperform in a year when the market goes up (it underperformed in 2009 off of the lows).

Any thoughts on the underperformance? Any cues from other times in the past when leading stocks have underperfomed?


A: IBD 85-85 index tracks stocks that are top performers in both fundamentals and technicals. The index's underperformance against a market that has moved higher up until September 2012 is another reason why 2012 is probably the most challenging year on record. Quantitative easing continues to manipulate the market reluctantly higher. Meanwhile, the trend following wizards continued to be collectively down for 2012 http://www.automated-trading-system.com/trend-following-wizards-september-2012/ with several wizards showing double digit percentage underperformance, even though the major market averages are up double digits percentages. Even the great Dunn Capital is down -17.78% and JWH & Co is down -21.13%. Both were interviewed extensively in Michael Covel's book Trend Followers. What we are seeing is almost unprecedented, with the only other year this occured being 2011, as 2011 was trendless, volatile, and news-driven creating a series of gap ups and gap downs in a market that could rarely find direction.

By the end of March 2012, the trend following wizards were collectively down 2012 despite the market being in a seeming uptrend. The uptrend, however, was illusory as it was mostly driven by Apple (AAPL) and a scant handful of other names such as Priceline.com (PCLN) during the first quarter of 2012.

As we wrote in an August 10, 2012 note from our website, “2012 is reminiscent of the second and third quarters of 1999 when the model had its largest drawdown in its history. During the second and third quarters of 1999, the NASDAQ Composite was the most volatile and directionless in its near 30-year history giving the Market Direction Model its worst drawdown at that point at -15.7%. Since then, 2012 has traced out an equally unusual situation, especially during the months of May through early August when the market moved just enough to trigger false buy and sell signals, giving the model its worst drawdown at -18.2%. Fortunately, such periods are aberrations and always have come to an end. Eventually, the market will catch a sustained trend. This has historically made a big difference in terms of overall performance over time, and this is the premise of the Market Direction Model.

First published: 24 Oct 2012
Last updated: 3 Oct 2014