Percentage of Stocks in a Bear Market: Nasdaq vs. S&P 100
Yesterday, Bloomberg published a provocative article indicating that 47% of Nasdaq stocks were currently in bear markets, i.e., at least 20% off of their 52-week high. As stats wonks, we are attracted to these types of studies (and a little jealous when someone else discovers them). Thus, we were immediately intrigued by the article and the data point, particularly as, on the surface, it appeared to lend evidence to the thinning market meme that we have been describing.
The first step was to run the test to independently verify the 47% figure. We did so and found around 45% of Nasdaq stocks were down 20% from their 52-week high — close enough. Suffice it to say that sounds like an alarmingly high number.
That leads us to the second step: determining context. 47% sounds high but is it really? Well, we ran the test since the beginning of the year and as it turns out, the percentage has been above 40% for most of the time since March. So it may be high, but it isn’t an extremely recent development. If it is one of those divergences that we’ve observed so often lately, it is apparently another one that can persist for some time before causing real damage to the major averages.
Speaking of major averages, one of the takeaways from this study is how the averages can mask broad weakness throughout the market. Due naturally to their high weighting, the biggest stocks by market cap can keep the averages afloat, or rising, if they are doing well — even as much of the broad market is mired in a bear market.
More evidence of that effect is seen from the other series on the chart. Measuring the percentage of stocks in the S&P 100 (the very largest companies) that are in a bear market, we get exactly 1%, i.e., 1 stock (it is General Motors, if you are wondering). That is testament to the strength of the large caps and the resilience of the major averages. It also speaks to another takeaway from this study: stick with the relative strength leaders.
Lastly, to truly determine the significance and context of this statistic, we would have to view its historical data. In the article, Bloomberg mentioned that the number of Nasdaq stocks in a bear market in October 2007 was “about 45%”. However, since we do not have data with timely constituent changes for the Nasdaq going back several years, we cannot generate historical numbers. We could theoretically reproduce it by rebuilding the Nasdaq week-by-week, but that would be too time-consuming a task for us. It would be great if anyone had the data and could share the figures or chart so that we could get a true historical perspective.
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It is forming a potential short-term head-and-shoulders pattern with a neckline at $73.
It once set 2 major long-term highs at $73.
It sits on a key Fibonacci Retracement line and its 200-day Simple Moving Average at $73.
Because of those factors, XOP is…The Most Interesting Chart In The World! OK, maybe the effect is lost a bit without the voice-over and the outlandish visuals, but at least to us, the chart of the SPDR Oil & Gas Exploration And Production (XOP) is very interesting at the moment. It is currently partaking in an epic battle at $73.
First, the short-term:
The ETF is forming a distinct Head-&-Shoulders pattern with a neckline at $73. This is a very bearish pattern and a break of $73 would target an area around $63.
But before one gets hog-wild bearish, check out the significance of $73 on a long-term basis:
XOP set major highs at the $73 level in 2008 and again in 2013. This theoretically provides serious support at that level.
Throw in the key 23.6% Fibonacci Retracement of the post-2011 rally and the 200-day Simple Moving Average, both right at $73, and the significance of the level is obvious.
So how does one play it, should one be so inclined? Simple: XOP is bullish as long as it holds above $73. A break below is bearish. Oil has been getting pounded and has taken a toll on XOP. That is likely the wildcard. It is hitting some key support at the moment so it could be the impetus for a bounce in it, and in XOP.
Usually charts are somewhat muddled, with contradictory signals coming from all different directions. This one is as straightforward as they come. For XOP, $73 is the key.
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Perhaps no market in recent memory has been so characterized by the theme of “rotational leadership” as the post-2013 rally. Countless sectors and industries have taken turns stepping up to lead this market. Thus, for all the red flags and warts on this market, the continuous emergence of new leaders has helped maintained that persistent bid under the market.
One of the most recent sectors to step forth and grab the leadership mantle, speaking of warts, has been the broker/dealers. Despite the cyclical (or secular) decline in equity volume and the concern over the lack of bond supply, the stocks of broker/dealers have been exceptionally strong of late. Last Friday, as the S&P 500 closed down 0.6%, the NYSE ARCA Broker/Dealer Index (XBD) was up 0.6%. For the week, the XBD was up over 4%, breaking out to a 6-year high in the process.
The XBD breakout level corresponded with highs in January, March and July of this year, as well as the 50% retracement of the 2007 to 2008 decline, adding significance to the breakout. The higher lows since April arguably make up the lower bound of an ascending triangle. As long as the XBD holds the general breakout level around 165, the breakout of the ascending triangle would imply an upside target of roughly 8% to about 186. This level would also correspond with the 61.8% Fibonacci Retracement of the 2007-2008 decline.
One caveat exists that we would be remiss not to bring up, however: the pace of the leadership rotation. Whereas historically, leadership has tended to rotate on the order of quarters and years, the current market seemingly has new leaders every month. This has actually presented a challenge for trend-following hedge funds and portfolio managers. They have consistently been zigging while the market is zagging.
That is, they have been buying strong areas that, in the past, would have continued to display relative strength for some time. However, due to the faster than usual rate of turnover, these strong areas have quickly and repeatedly reverted to weakness in short order. Conversely, attempts at selling/shorting weak areas have recently been met with abrupt v-bottoms and bounces straight back to previous highs. This has been the era of false breakouts/breakdowns.
Therefore, it is possible that this move will turn out to be another failed breakout. However, the setup, historically, is a sound one that presents a better than 2:1 reward to risk ratio that the broker/dealers still have something left in the tank.
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"NYSE" photo by James Scott.
Equal Weight S&P 500 Starting To Lag - Shades of 2007?
Another divergence post? Yes, sorry, we know it is getting mundane. However, we post what we see and there is an abundance of divergences present in today’s market. Eventually, they will likely succumb to a negative resolution. However, as we have stated many times, the problems with relying on divergences are that A) they can last for a considerable amount of time and B) they may ultimately resolve positively, i.e., the lagging component catches up to the leading component, dissolving the divergence.
Today’s divergence du jour/Chart Of The Day deals with the ratio of the Rydex Equal Weight S&P 500 ETF (RSP) to the SPDR S&P 500 ETF (SPY). SPY is a typical cap-weighted ETF, like the index itself, in which weighting is based on each stock’s market cap. The bigger the cap, the larger the weighting. RSP weights each component equally and, thus, its performance is a good barometer of the level of participation among all stocks.
As we have discussed often, it is preferable to have as many stocks as possible performing well. The more stocks participating in a rally, the healthier it is. Therefore, when RSP is doing relatively well, the market is on healthy footing. Indeed, in the chart, one can see that during rallies, the relative performance of RSP to SPY has usually sloped upward. Once the ratio turned lower (i.e., lower highs and lows), the overall market suffered.
In 2007, the ratio flashed essentially its only divergence in its more than 10-year existence. It topped out in February of that year and made lower highs as SPY made higher highs in July and October. Obviously, in hindsight, the divergence was a good early warning sign of trouble to come.
In recent months, the ratio has begun to diverge again. It topped initially in February then made a slight higher high in June. However, it has essentially been moving sideways for the past 7 months, even as the market has made higher highs. During the market’s recent move to new highs, the RSP/SPY ratio made a noticeable lower high. This divergence could continue for some time and it could eventually be resolved positively with the ratio moving to a new high. For the time being, however, it is yet another divergence “red flag”.
(Note: In late 2006 and from 2011-2012, the ratio displayed temporary divergences as the market was either emerging from a correction or trending sideways. Once the market moved to a higher high, the ratio did in fact “catch up” to a new high as well.)
Given the number and persistence of many current divergences, we likely will not post on too many more of them unless the divergences are particularly egregious. That said, a steadfast climb — like the market we are now witnessing — that refuses to pay any heed to normally relevant warnings can numb investors to such things. That can be a dangerous condition if investors begin to shun all risk warnings whatsoever. That is when potential risk will likely manifest itself. As Verbal Kint put it in Usual Suspects, “The greatest trick the devil ever pulled was convincing the world he didn’t exist”.
Therefore, while we will try not to get caught up in overplaying some of these traditionally cautionary divergences — like the underperformance of the Equal Weight S&P 500 — we will also steel ourselves against dismissing them outright.
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Commodity Spotlight: Oil Ready To Stop Getting Drilled?
On July 23, we pointed out several layers of resistance faced by the United States Oil Fund, USO. It topped that very day at $38.30 and has dropped roughly 10% since. It is now hitting multiple support layers near the $34 level, including:
- 50% Fibonacci Retracement of the post-2012 rally
- 61.8% Fibonacci Retracement of the post-2013 rally
- 78.6% Fibonacci Retracement of the post-January rally
- Post-2012 uptrend line
Should USO not hold the $34 level, there is also multiple support at $33, including:
- 61.8% Fibonacci Retracement of the post-2012 rally
- 78.6% Fibonacci Retracement of the post-2013 rally
- January Low
- Post-2009 uptrend line
Holding the $34 area would be preferable for bulls as it would signify another higher low, maintaining the possible ascending triangle in place since 2012 and suggest an eventual upside resolution to the 3-year trading range. Should prices drop to $33, it would approximate the January low, setting up a horizontal trading range. The breakout from that would be even odds, up or down.
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Quick, name the country whose stock market hit a 6-year high yesterday. OK, besides India…and Argentina. Believe it or not, it is Japan, at least as measured by the TOPIX Price Index. The TOPIX is a broader index than the more popular Nikkei 225 which is still trading below its high set around the beginning of the year.
Yesterday, the TOPIX arguably broke above a triple top just above 1300, marked by closes in May 2013 and January and July of this year. Those high closes also marked the upper bound of a possible 16-month Ascending Triangle. Should the breakout be successful, a standard measure would suggest a possible target around 1550 (which is also the 38.2% Fibonacci Retracement of the 1989-2012 decline).
It remains to be seen if the weekly close tomorrow will hold above this level. If it does, longs based on this breakout can be established. A weekly close back below the 1330 level would be a natural stop loss point.
There are a few reasons why we are a little skeptical of this breakout (besides 25 years of non-stop disappointment doled out by the Japanese stock market). For one, considering the yen collapse the past few weeks, it is somewhat surprising the TOPIX hasn’t made an even stronger move. While we do not like to apply causality to market moves, considering the recent correlation it is not a stretch to link the move higher in Japanese stocks to the weakening yen. In addition, several other indexes have not confirmed this new high in the TOPIX, including the Nikkei 225 and various small cap indexes. Lastly, it would be a bit premature of a triangle breakout. Typically we like to see a few more touches of the upper and lower bounds and see the index approach the “point” of the triangle a little closer before the breakout transpires.
Nevertheless, we have learned to take moves at face value because, as they say, price is truth. And the TOPIX Price Index is at a 6-year high.
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"Fuji" photo by Janne Moren.
UPDATE: Taking Partial Profits In High Yield Short
On August 15, we outlined our longer-term bearish case toward high yield bonds as well as a shorter-term chart-based rationale for an entry point for a short. Today, we see ample evidence for taking partial profits on that short position…for now.
We are still just as negative long-term on the high yield space. However, trying to time a short in a manic-driven asset is a perilous endeavor. Therefore, though this bear battle will likely be a long-term affair, for now, attempting to be somewhat surgical with shorting attempts may be the sensible strategy.
If high yield bonds are indeed topping, it will probably be a drawn-out process filled with ups and downs. Eventually, a “waterfall” type collapse is possible and holding a partial position still is advisable for that possibility. However, we don’t suspect that moment is here yet. Therefore we don’t think it is yet time for a “short-and-hold” strategy.
The current move down looks quite possibly to be a retest of the August 1 low. If that is the case, the 92.5 level on the iShares High Yield Bond ETF (HYG) marks the 61.8% Fibonacci Retracement of the August rally. That would be a logical place for HYG to bounce — unless of course it is not the beginning of the waterfall.
We would likely see fit to add this short piece back at higher prices.
Nasdaq near 52-Week High…but more New Lows than Highs
We’ve been discussing the gradual thinning of the stock market rally over the past several months. Again, it is preferable to have as much participation from as many stocks as possible supporting a rally. When only a relatively few stocks are holding the market up, it is more susceptible to a decline when those stocks give up the ghost since the market lacks that broader foundation. Yesterday’s action produced a particularly egregious example of the thinning foundation. While the Nasdaq Composite closed within 1% of its 52-week high, there were actually more New 52-Week Lows than Highs on the Nasdaq exchange.
This situation has been an extremely rare occurrence. It has happened on just 27 days (mostly in clusters) over the last 28 years, including on July 28. The track record following these readings is quite dubious, with one major exception.
- Following 2 occurrences in December 1996, the Nasdaq rallied for another month before dropping 14% over the next 3 months
- In July 1998, the Nasdaq peaked 9 days after an occurrence, losing a third of its value over the next 3 months
- It happened several times in 2007, once in May then 4 times from June 21 to July 18. The Nasdaq dropped about 12% in a month starting on July 19. There were 4 more occurrences in October 2007 leading up to the cyclical market top.
The big exception was during the extraordinary blowoff from 1998 to early 2000 when this condition emerged no fewer than a dozen times. We’ve discussed this period on many occasions. While most stocks were actually mired in a bear market, the Nasdaq soared to parabolic heights on the back of a relatively few high flyers. The monumental collapse following the bubble top reveals the potential risk once a thin rally peaks.
The present thinning of the stock market rally is a serious concern. Such thinness is exemplified by the near new high in the Nasdaq Composite with more new 52-week lows than highs. While this condition has often occurred a bit in advance of the subsequent market peak, it has almost always preceded an intermediate-term correction of significant magnitude. The major exception was during the blowoff top in the late-1990’s. While it is always possible that a similar type move is pending, even the most ardent bulls may want to at least have an exit strategy or risk controls in place should it not transpire.
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Continuing our series on international stock market breakouts, today we feature the Hong Kong Hang Seng. FYI, we did not plan this series, we simply go where the opportunity is — and there is a whole lot of it internationally at the moment. This includes the Hang Seng which has recently broken above a triple top that was formed precisely at a key resistance level.
If you’ve read a lot of charting books or blogs, you may have come across the idea of using multiple time frames as an aid in clarifying analysis. It is solid advice and the Hang Seng chart is a good example of this. When looking at the daily or even weekly chart on the Hang Seng, we see a fair bit of “noise” or whippy price action from 2010 to 2014 in the vicinity of the recent breakout level. However, when we “zoom out” to a monthly view, the key resistance level becomes clear.
The important 61.8% Fibonacci Retracement of the decline from 2007 to 2008 lies at 23,829. The importance of that level has been reinforced by the fact that the highest monthly closes since the 2008 low each occurred within a half a percent of that level at 23,721 in April 2011, 23,730 in January 2013 and 23,881 in November 2013. By viewing the chart on a monthly scale, it becomes clear that the 23,800-900 level is the definitive level to overcome in order to confirm a breakout.
Accordingly, the Hang Seng broke out in July when it closed at 24,757. In August (we would have liked to have published a post but didn’t get the chance), it pulled back to test the breakout level, bouncing immediately from the level. A close below that breakout level now becomes a natural stop loss point for longs.
What sort of upside potential does the Hang Seng have given this breakout? To reiterate what we’ve said before, we are not big proponents of price “targets”, except in the case of a short-term trade within a defined range. We’d rather just follow the trend as long and as far as it goes. That said, for a general idea of the potential, various chart analyses yield the following “targets”:
- 161.8% Fibonacci Extension of 2010-2011 decline: ~31,000
- 61.8% Fibonacci Projection from 2008-2010 rally: ~33,000
- 2011-2014 Ascending Triangle breakout: ~32,000
- 2008-2014 Ascending Triangle breakout: ~38,000
Some possible areas of resistance include:
- 78.6% Fibonacci Retracement of 2007-2008 decline: ~27,500
- All-time high: ~32,000
Sometimes using a different time frame can clarify one’s analysis of a stock or index. By zooming out to a monthly time frame on the Hong Kong Hang Seng, we can see that it broke out above a clearly defined resistance level consisting of the 61.8% Fibonacci Retracement level of the 2007-2008 decline as well as a triple top of monthly closes from 2010 to 2013. Though it may not happen immediately, given the breakout, a move back towards the all-time high around 32,000, or 28% from current levels, would not be surprising.
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Sunrise over Hong Kong photo by slack12.
Unchanged Issues: The data column everyone ignores DOES have value
Considering the vastness of an entity like the stock market which aggregates millions of decisions on the part of millions of participants, resultant price movements, or non-movements, necessarily carry valuable information (you might all it the ultimate “big data” mechanism). This includes seemingly useless or random data series. Take the tally of “Unchanged Issues”, for example. Most observers presumably never even glance at that data column when perusing their source of choice for market statistics. However, Unchanged Issues can, at times, reveal information about the collective emotional state of investors.
Specifically, we have observed that the level of Unchanged Issues tends to rise as markets rally, often reaching some measure of extreme near tops. We would surmise that this has to do with rising complacency that is present near market tops (in varying degrees depending on the significance of the top). As long as the market seems to be on good footing, there is relatively less concern and interest, at least in the most illiquid or inactive stocks. Obviously, an exception to this tendency would be stocks caught up in the bubbly or high profile sector at a given time.
Conversely, when stocks are selling off, it can create more of a sense of urgency on the part of traders (or investors) to “tend” to their positions. And the worse the sell off, the more urgency is created. This heightened sense of awareness in periods of stock market declines fits with scientific studies that have found that “fear” is a much stronger emotion than “greed” (a finding that we would definitely concur with from our own experience). As a result, more action tends to be taken (out of fear) when stocks are selling off than when they are rallying (out of greed).
Applying this observation (or truth?) to current circumstances would lead to one conclusion: investors are more complacent than they have been in a very long time. On August 20, the % of NYSE issue that were Unchanged on the day reached 6.1%. This was the highest daily % since 2003 and the first time it reached over 6% since February of 2007.
When smoothing out the data by using a 10-day moving average of the Unchanged Issues, we find that the series is still at the highest level since very early in 2004. By applying Bollinger Bands (200-day look-back), we can attempt to ascertain on a dynamic basis when the series reaches high or low extremes.
Since 2008, in particular, moves by the 10-day average of NYSE Unchanged Issues above the upper Bollinger Band have been relatively accurate markers of high extremes in Unchanged Issues and a complacent, or overbought, stock market. Unchanged Issues gave such signals leading up to intermediate-term market tops in May 2008, January and March 2010, April 2011 and August 2012. It also gave false signals in July 2009 when the market was still emerging from the bear market and February of this year so the indicator is not perfect.
With the immense amount of input continuously pouring into the stock market, the significance of seemingly insignificant data series should not be overlooked. This includes the level of Unchanged Issues on the exchanges, which can be a decent indicator of overall investor complacency when at relatively high levels. Currently, Unchanged Issues are at their highest levels in 10 years. While this may not be the most alarming of all the intermediate-term concerns we have pertaining to stocks at this time, we would consider it a negative for the market.
UPDATE: Time To Take (some) Profits In China ADR’s
On July 29, we posted a chart showing the breakout in the Bank of New York Mellon China ADR Index. The index not only broke out to a 6-year high but it did so convincingly, on the largest weekly gain in 3 years. After briefly testing the breakout point, China ADR’s have followed through brilliantly to the upside, climbing by about 10% in the past month.
At the time, we noted that the first serious resistance may come at the 61.8% Fibonacci Retracement of the 2007-2008 decline at around 519. The Index is now trading at precisely that level. Thus, we view it as an attractive spot to take “some” profits.
We say “some” because, considering the strength of the breakout and strong follow-through, there is probably a high probability that the run is not over to the upside (and maybe not even close to over). Since we always like to let winners run, we’d keep the majority of the position. However, this would be a logical point for at least a pause so taking 10-20% off the table is not a bad idea.
Consider it house money. If the index does not so much as pause and keeps running higher, you still have the majority of the original position. If Chinese ADR’s do pull back, the position can be bought back for a potential next up leg.
How deep could a pullback be? Though it would not be the most ideal scenario for longs, the reality is that Chinese ADR’s could possibly pull back all the way to the breakout point without invalidating the breakout or uptrend. If it did, investors will be happy that they at least took some money off the table.
With much of the investment world intently scrutinizing each tick in the S&P 500 and parsing each syllable uttered by an American and European central banker, much of the stock market action in the rest of the world flies under the radar. There is actually a lot of good stuff going on, from potential major bottoms/turns (Emerging Markets, Latin America, etc.) to new 52-week highs (Australia, Hong Kong, China, Asian EM, etc.) to potential all-time highs (India, Canada, UK, etc.) As of yesterday, you can add Mexico to that last category.
Our last post about the Mexican IPC Index came on Cinco de Mayo (May 5). Consider this an update. In that post, we noted the bull flag developing at the time at the 61.8% Fibonacci Retracement of the December to March sell off. We suggested it was likely to break out above that level and test the 61.8% Fibonacci Retracement of the January-June 2013 decline (around 42,700) which had repelled the market on 2 occasions, in August and December of last year. We didn’t have to wait long for that breakout as it happened the very next day. Within a week, the IPC had already rallied some 5% up near the key 42,700 mark.
After initially being rejected by that level in May and again in June, the IPC broke out above it and has not looked back. In fact, it is now up 7 months in a row without as much as a 3% pullback. And, as mentioned, yesterday it broke above the previous all-time high set at the January 2013 high.
The breakout of the 61.8% Fibonacci Retracement of the 2013 decline and now subsequent rally to new highs is actually pretty significant, in the big-picture. Since arguably commencing a secular bull market in 2003, the Mexican stock market has steadily made higher highs and lows. The high of last December looked to be a potential lower high setting up a possible cyclical bear market upon a break of the June 2013 lows. However, the higher low in March combined with the break above the 61.8 level and now new highs confirms the persistance of the secular bull.
That said, all is not bueno for this market — at least in the short-term. Considering its recent run, the market may be in need of a siesta before another leg up begins in earnest. At the very least, some consolidation would would set up a more attractive entry point. Why do we say this?
For one, the market is up 7 months in a row. Momentum can certainly drive it a bit higher in the near-term but, historically, it has not gone much further after reaching such a streak. To put it another way, it is overbought, as its weekly reading on the Relative Strength Index of 74 would attest. Furthermore, the best, most sustainable breakouts are those that consolidate at the previous highs before breaking out. This can allow the market to work off the overbought condition as well as rid it of traders’ profit-taking spurred by the move to the previous high level. After such action, the market will have more “energy” to make a sustainable run to new highs.
Lastly, from price projection analysis, several indications point to a rest in this area. These stem from the bottoming action between June 2013 and March 2014.
The projection analysis and resulting targets include:
Double-Bottom (June 2013 & March 2014) Measured Target = roughly 48,000
61.8% Fibonacci Projection of June-December rally = roughly 46,800
161.8% Fibonacci Extension of December-March decline = roughly 46,500
What is the takeaway? The Mexican stock market has broken out to all-time highs. There is nothing more bullish than that. It also confirms the secular bull market is still intact. However, it is overbought in the near-term. Some consolidation nearby is likely, based on projected targets. This consolidation could provide for an attractive entry point and a springboard to the next leg up in the Mexican bull market.
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Mexico Flag photo by Rodrigo Reyes Sànchez.
Is the duration of the small cap divergence a concern?
We have commented on many occasions about the importance of broad participation of stocks and sectors on the health and sustainability of broad market rallies. Sure, at times only a few market sectors seem to be carrying the load in a “thin” rally. At other times, “leadership rotation” is the buzzword as different stock segments take turns leading the way. This rotational dynamic has characterized much of the rally in stocks during 2014 as former leaders have fallen by the wayside and new leaders have stepped up. The problem is, eventually these thin or rotation based rallies run out of leaders and that leads to the end of the rally.
Of course, as we discussed the other day regarding the lack of 52-week highs, these types of divergences can last for many months with the major indexes continuing to gain. The challenge is to try to identify if there is a “breaking point” at which the divergence exerts its pressure on the market. It is in that vein that we present our Chart Of The Day looking at the divergence in the Russell 2000 Small Cap Index. Specifically, we examined the length of the divergence in which the S&P 500 is at 52-week highs yet the Russell 2000 is not.
As the chart indicates, at the most recent 52-week high in the S&P 500 (on 9/2), it had been 125 days since the Russell 2000 had made a new high itself. Is that extreme? And is it a cause for concern? Well, there are basically two ways this divergences can resolve itself. The Russell 2000 can catch up to the S&P 500 in new high ground or it can pull the S&P 500 down, causing a correction (or worse), refreshing the market before the cycle starts over again.
Looking at the history of the Russell 2000 (since 1991), this is the 12th divergence lasting 100 days. In many of the previous instances, it was a case where the market was emerging from a decline or long stagnation and the S&P 500 simply made a new high first before the Russell 2000 caught up in fairly short order. This was the case in 1992, 1995, 2004, 2006, 2009 and 2010.
In late 1996, the divergence reached 159 days and eventually pulled the S&P 500 down into a very mild correction in the beginning of 1997. This refreshed the market and provided a springboard for a big rally later that year.
In March 1998, the divergence lasted exactly 100 days before the Russell 2000 caught up and made a new high. It was a short-lived new high, however, as the market reversed shortly after and suffered a sharp bear market in the second half of 1998.
In 1999, the divergence reached over 300 days in what might be called the “great divergence” as large caps rallied strongly through early 2000 even as most stocks were still suffering through bear markets. The market finally did succumb to the divergence pressure and corrected from July through October of 1999 before the blow-off move into 2000.
The last two instances came in 2012. These were sort of a hybrid of the two resolutions as the S&P 500 was able to make slight new highs in April and September while the Russell 2000 did not, resulting in divergences of 234 and 344 days. Initially following each instance, the market corrected some 8-10%. Ultimately, each index moved to new high ground in early 2013.
So 6 of the divergences of 100 days or more resulted in the Russell 2000 catching up to the S&P 500 at new highs. 4 of the others resulted in mild-moderate corrections before the market resumed its advance. Only in 1998 did the market suffer major damage following the divergence. So historically, it does not appear to be as much of a worry as commentators often suggest.
So what will transpire from the current iteration? The general odds say there is not a whole lot to worry about from the divergence. That said, if there were any precedents that most closely resemble the current divergence, it would probably be either 1996 or 1998. These long-duration divergences came after long rallies, not after emerging from declines. The 1996 occurrence led to a brief blip lower before accelerating in a massive move to the upside. The 1998 instance preceded a brief blip higher before a significant 20% decline. So, judging by these two binary precedents, the divergence has a 50-50 chance of a very positive or very negative resolution.
What is our takeaway? Long-duration S&P 500-Russell 2000 divergences have not led to the calamitous types of events one often hears warnings about. 10 of the 11 such historical precedents have led to only moderate hiccups in the market. The two most similar to our present divergence, however, have had split results, including a bear market. While we have no way of knowing the ultimate outcome, our guess, given current conditions, is that the odds of a poor outcome are probably closer to 1 in 2 than 1 in 11.
OK, so Paul Revere wasn’t talking about British stocks; but he might have been had he seen the potential development in the London FTSE 100. After closing at 6930 on the final trading day of the last millennium (12/30/1999), the index has remarkably failed to trade above 6900 one time since. Today, it came the closest it has in 15 years, hitting 6898. Should it break out above 6900, the FTSE has the potential to run significantly higher.
We never want to anticipate a breakout. And indeed, we have been watching for a breakout in the FTSE since January with nothing doing yet. That said, there is plenty to like about the chart and its potential to support a breakout.
For one, as we mentioned in the January post, there is a potential cup-and-handle formation on a long-term basis using the 2007 and May 2013 highs as the sides of the cup and the current high as the handle. Additionally, there is a potential cup-and-handle on a shorter-term basis with the May 2013 an May 2014 tops serving as the cup and the current high completing the handle. This is a powerfully bullish formation that can support much higher prices, upon a breakout.
Even if one does not interpret the action of the past 15 months as a cup-and-handle, it has at least consolidated very tightly up near the 15-year highs in the 6800’s. It is now like a coiled spring ready to accelerate out of the consolidation — whichever way it breaks. I like to think of it as a superball bouncing through a hollow tube. Once it reaches the hole at the end, it is released in a powerful burst. The fact that the FTSE has been making higher lows since 2013 as it has consolidated suggests that it is forming an ascending triangle, a pattern that typically resolves to the upside.
Whatever formation one interprets the recent action to be, it appears to be a continuation pattern of some kind — meaning it will resolve itself in the direction of the prior primary trend, i.e., up. Assuming a breakout to the upside, we can derive certain targets from various patterns in the chart. For the record, we are not big proponents of price “targets” per se, as we simply follow what prices are telling us. However, by studying the chart patterns, we can at least get a general idea of a chart’s potential. Here are some potential price targets suggested by various patterns on the FTSE chart:
- The 161% Fibonacci Extension based on 2007-2009 decline yields roughly 8800 (+30% gain)
- The 100% Fibonacci Projection based on 2009-2011 rally yields roughly 8750 (+29% gain)
- The projection based on 2007-2012 Triangle breakout yields roughly 9100 (+34% gain)
- The initial projection based on a potential 2013-2014 Ascending Triangle breakout yields roughly 7800 (+13% gain)
Again, we caution investors or traders against anticipating a breakout. This is particularly true of setups on a long-term scale such as this. Should the FTSE 100 break out, there is plenty of potential further upside to reap.
So wait til you see the whites of the eyes above 6900.
Read more from Dana Lyons, JLFMI and My401kPro.
Redcoat March photo by Jason Bolonski.