This Tale of Two Markets Should be Near its Final Chapter

by James Brumley | May 21, 2014 2:14 am

As has been the case too many times since March, Tuesday’s action quelled a recovery effort before it even had a chance to get rolling. The Nasdaq tumbled 0.7%, while the Dow industrials lost 0.8%. The Russell 2000 continued its outsized struggle, falling 1.5%, and is now more than 9% below its March 4 peak. For perspective, the S&P 500 is essentially unchanged during thatperiod.

There were no bright spots Tuesday, but there was notable trouble on the retail front. Staples (SPLS[1]), Urban Outfitters (URBN[2]) and Dick’s Sporting Goods (DKS[3]) all posted disappointing numbers, and their stock prices paid dearly for it. The SPDR S&P Retail ETF (XRT[4]) closed 2.5% lower, which was the biggest decline among the major sector ETFs.

Contributing to the market’s weakness was chatter of a potential rate hike from the Federal Reserve, although that chatter didn’t actually raise yields. The 10-year Treasury note’s yield slipped from 2.54% to 2.51%.

While volume was slightly higher on Tuesday than it was on Monday or Friday, it could still only be described as tempered. Yet, there’s a red flag subtly waving under the market’s breadth-and-depth hood. The NYSE’s decliners outnumbered the advancers by more than 2.3-to-1, while the Nasdaq’s advancer/decliner ratio was an equally unhealthy 3.2-to-1. The bullish/bearish volume ratio for the Big Board looked even worse at 4.2-to1, though the Nasdaq’s bullish and bearish volume ratio rolled in at 3.2-to1.

The S&P 500, however, simply continues to dance in the middle of a sideways trading range that’s been in place for weeks now. It became clearer on Tuesday that the ceiling of 1,885 is going to be a point of contention. The message was delivered in the form of another close below the 20-day moving average line at 1,879. On the other hand, the 50-day moving average has once again proven itself to be a technical floor.

SPX Chart
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Chart Key[5]

From a momentum/MACD perspective, the action still looks technically bearish, though the S&P 500 continues to find support at higher and higher levels. It also continues to apply pressure to its resistance. The next move above 1,885 would be the third one, and may well be the one that remains in place to set up a base from which a prolonged rally could actually be launched.

That chart remains in sharp contrast to the action we’ve been seeing from the Russell 2000, which continues to technically deteriorate. With Tuesday’s setback the small-cap index looks poised to make another lower low.

This could be a particular problem for the Russell 2000, not to mention the market as a whole, as the next lower low here would pull the index below 1,080, which would mean new multi-month lows. The fact that the 20-day moving average is now below the 200-day moving average will only make it that much tougher for the bulls to stage a recovery effort — not that one was in the cards.

RUT Chart
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Conclusion: It continues to be a tale of two markets. The S&P 500 offers hope here at the cusp of a breakout, while the Russell 2000 seems content to lose more ground with no end in sight. In fact, one more sizable tumble from the Russell 2000 could actually accelerate the selling effort.

Given the dichotomy, the best course of action may well remain one of relatively little action until there’s some greater clarity on the market’s true undertow. On Monday[6], it was suggested that a 60% stocks/40% cash allocation remains appropriate, and that’s not changed.

That being said, given the time of year, the arguably bloated valuations heading into earnings season (against a backdrop of rather troubling Q1 earnings performance), in addition to the bear market warning that small-cap indices have doled out since March, the bulls may be wise to maintain a skeptical, “show me” attitude.

That’s not to say the odds are against the market. It’s just to suggest all the indices should participate in a summertime rally if it’s to be trusted for any length of time. This means the Russell 2000 needs to cross back above a key resistance level currently around 1,120 should the S&P 500 manage to break above — and stay above — 1,885 and give us a bullish signal. Otherwise, it may just be more of the same go-nowhere choppiness.

The good news is, we’re closer to whatever breakdown or breakout is going to take shape from here; the market can’t remain this at odds with itself indefinitely.

The bias remains bullish, as does the longer-term momentum despite the Russell’s temper tantrum. That could change in a hurry, however, if the S&P 500 finally breaks under 1,850 and threatens 1,813.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

  1. SPLS:
  2. URBN:
  3. DKS:
  4. XRT:
  5. [Image]:
  6. On Monday:

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