The stock market in 2018 certainly looks different than it did in 2017. Whereas last year was smooth and upward sloping, this year is, at least so far, volatile and directionless. However, if we just lift up the market’s hood just for a moment we will see plenty to keep the faithful engaged.

Fundamental analysis has all sorts of ratios to measure the health of a particular stock or the market as a whole. Price/earnings, return on investment, debt to equity, price to book, and the list goes on and on. It’s a regular alphabet soup of things to calculate.

Not to be left out of the fun, technical analysis has plenty of ratios of its own. The difference is that all of them depend on data gathered from the market and from participants in the market. None of them are estimated in the way an analyst can put a few inputs of his or her own choosing into a formula, also of his or her own choosing, and spit out what a company might earn next year.

Some might call that guessing. It’s guessing done by very smart people using very sophisticated tools but it attempts to predict the future. And they call chartists fortune tellers.

The Offense/Defense Index

One of my favorite “indicators,” and I write that in quotes, is what I call the offense/defense ratio. Full disclosure, I got the basics from a chart guy named Boris Simonder, many, many years ago. However, since I did not have the data he had, I substituted SPDR sector ETFs to arrive at similar conclusions.

Basically, it is a ratio of offensive, or aggressive, sectors to defensive sectors. Team offense is technology and consumer discretionary, represented by XLK and XLY, respectively. These are generally cyclical in nature. Companies invest in tech when they see improving returns a few months down the road and consumers buy stuff (substitute unsavory synonym here) when they feel flush.

Team defense is consumer staples and health care, represented by XLP and XLV. Both tend to have more stable business models because people buy food, cigarettes and drugs when they need them no matter how many times the Fed jacks up rates.

Here’s what the long-term picture of the index looks like now:

I see a spike up into the Internet bubble peak and a rapid fall from the pedestal during the ensuing bubble busting bearish breakdown. Sure, there was a rebound as equilibrium returned in 2003. And the financial crisis sent the index back into the toidy in 2007.

Sort of puts the first bear market on a different plane, right? I wonder what the 1930s and the 1970s would have looked like with this index.

Now look at 2010 to 2017. Dead flat as Steven Wright’s comedic delivery.

And that brings us to the election of 2016. With absolutely no comment on politics, look what happened to the ratio at that time. If broke out from a six-year triangle and then broke out from a 16-year base.

That was a big deal from the market’s point of view. And as Alan Shaw said in 1985 (well it was close to these words), the bigger the base, the higher in space. This was one big-a$$ base.

Alas, on this monthly chart we can see the index is overbought. That means it moved a bit too far, too fast making it vulnerable to a pullback – and on a monthly chart, that is some accomplishment. My view is that this pullback comes later this year but the overall bull market structure remains intact.

Let’s bring this to a more practical charting level. The weekly chart of the index shows a small bearish divergence between RSI and price action. That means momentum on this time scale is waning even as the index made a new high. It is another sign that a pullback is near.

So is the “divergence” in Bollinger Bands. Here, we see the index making a new high above the bands and then a higher high back within. It’s another way to say momentum is not our friend right now.

I don’t like drilling down too deeply here to the daily time frame because it’s more about major trends and not short-term timing.

However, my point is that despite the Fed and despite earnings and despite blah, blah, blah the market still shows a nice underpinning. Don’t forget it also shows a pending correction but it’s still nice for the long-term.