INVESTING: Riding waves a lot like navigating stock market

I like to surf. I’ve been doing it for 25 years and, although I live in Indiana, I indulge my hobby with a few quality trips a year.

One thing I love about surfing is the amount of fun I have without taking a lot of risk. Shark attacks are infrequent, and I don’t surf places with a history of them. And if the surf is so big as to be dangerous, I just stay out of the water. I always try to keep in mind that what I see on the surface of the ocean doesn’t come close to telling me the whole picture.

The stock market can often be like the ocean. On a calm, clear day, you can see for miles around and think it’s perfect for sailing or a nice, long swim. With the help of a barometer, though, you might see that a storm is coming. And if you looked at some statistics earlier, you might have noticed that this beach averages 10 shark attacks a year. Just because you don’t see them doesn’t mean they aren’t there.

Since the June 14 market low, the prevailing opinion on Wall Street is that the market must be in great shape to have held up in the face of all this bad news. There has been one call after another from the major investment houses to increase equity exposure because the lows are in and the bull market that began almost four years ago is still on.

It is undeniably true that the Dow Jones industrial average has held up in the last few months. The S&P 500 hasn’t done quite so well, but is still up almost 5 percent. Start to grab some statistics and your barometer, though, and you begin to see a starkly different picture.

One of my favorite indicators is the advance/decline line. This measures how many stocks are advancing and declining every day in a given index. The S&P 500 is up 5 percent since June 14, but the a/d line for the S&P has lagged those gains.

The NASDAQ market is about 100 points above the June low, but the a/d line broke to a new 52-week low a few days ago. The a/d lines for the small and midcap indexes are showing similar weakness. In other words, the indexes are moving higher, but most of the stocks within those indexes are not. This divergence typically leads to lower, not higher, prices.

Another alarming fact has to do with these small and mid-cap indexes. These were strong performers throughout much of the bull market. They have been suffering horribly since May, and this has the potential to turn into a serious problem for the rest of the market.

A lot of investors, professional and retail alike, ran full speed into these stocks last year. As their underperformance becomes more obvious, sellers will become more motivated. Intense selling in the smaller stocks can lead to selling across the board. A down draft can occur in which all stocks get marked down.

We are coming into the worst time of the year for stocks. Add in these other factors at play, and there are compelling reasons to be cautious about stocks for a while. Don’t forget that you can make 5 percent or more at a bank these days. Might not be a bad place to hang out until the storm passes or the sharks have had their fill.