How Strong is the Market Really?

We’re at an inflection point in the S&P Equal Weight Index… there’s greater strength over in the tech sector… the recent rally over the last few days has been more uniform

 

We’re at an important inflection point for stocks.

Over the next couple weeks, what happens could have a big impact on your portfolio.

To illustrate, let’s start by looking at a chart of the S&P 500. We’ll add an overlay called the “50-day simple moving average.”

As its name suggests, the 50-day is a line showing the average reading of the prior 50 days’ worth of market prices. It’s an important psychological line-in-the-sand for investors that helps them see the overall trend for a stock (or an entire market).

For example, if a price falls below the 50-day simple moving average, traders usually interpret this as a bearish trend change. To avoid potential losses, some traders will sell, which can intensify the move south, leading to even bigger price declines.

The opposite is true as well – a push north through a 50-day average is often seen as a bullish indicator. This can attract more buyers, which leads to bigger price gains.

So, where do things stand today?

Below, look at how the S&P’s 50-day simple moving average has served as a springboard for its price all year long.

Each time the S&P has fallen, the 50-day simple moving average (or just below it) has served as a powerful baseline/bounce point, sending prices north again.

As you can see on the right edge of the chart, it’s happened again this week. After a steep drop that took prices down near the 50-day (hitting the low of that move this past Monday), the S&P has rebounded nicely to round out the week.

This chart is a fantastic way to gird yourself against the doom-and-gloom that’s been filling headlines in recent days.

***But now, let’s add a twist that suggests our bullish bias shouldn’t get too far ahead of itself

The chart above doesn’t tell the whole story. That’s because there’s something happening under the surface that deserves your attention.

To make sure we’re all on the same page, the S&P 500 Index is comprised of a shade more than 500 of the largest companies in the United States (505, to be exact).

However, all of these companies don’t get equal representation in the index. That’s because the S&P is “weight-averaged.” In other words, the bigger the company, the more “representation” it has in the index. Given this, when we look at the S&P, we’re not viewing an accurate depiction of how its average stock is performing.

To illustrate, if each company in the S&P 500 received an equal weight, that would mean a standard allocation of roughly 0.20%. Instead, the biggest company in the S&P 500 – Apple – gets a 6.3% weighting. That’s followed by Microsoft at 5.7%, and Amazon at 4.2%.

This means that these mega-cap tech stocks have an outsized influence on the performance of the S&P 500. So, if we’re trying to get a sense of how all the S&P stocks are doing, this isn’t the best chart to evaluate.

Instead, we’d look at a different index – the S&P 500 Equal Weight Index. As the name implies, this gives us the equal representation we’re looking for.

Below, let’s look at this S&P Equal Weight chart, adding in its 50-day simple moving average. Give it a look before we add any commentary.

As you can see, whereas the 50-day trend line was still “up” for the S&P 500 chart from a moment ago, the 50-day trend line of the Equal Weight Index has gone sideways. In fact, if you look closely, it was slightly down earlier this week.

Second, the market price of the S&P 500 Equal Weight has now dropped substantially below this 50-day trend line twice since mid-June. This doesn’t mean that the Index is about to roll over, but we certainly can’t say it’s bullish.

Third, whereas this week’s gains since Tuesday have propelled the S&P 500’s price substantially north of its 50-day trend line (the first chart in today’s Digest), that same market strength has only returned the S&P 500 Equal Weight to its 50-day trend line.

Stepping back, the technical term for what we’re evaluating is market “breadth.” It’s basically the extent to which many, or few, stocks are participating in a market move.

If our bull market is to continue in a sustained, healthy way, we need broad breadth from all stocks – not just the big ones.

***We’re seeing something different in the tech-heavy Nasdaq

Below, let’s look at the Nasdaq 100 Index (technically, it’s the 102 largest non-financial stocks on the Nasdaq), compared with the Nasdaq 100 Equal Weight Index.

As you’re likely aware, the Nasdaq is a proxy for “tech.” So, by focusing on these indices, we’re zeroing in on a specific corner of the market.

Now, remember, just a moment ago, we saw how the average Equal Weight S&P stock was sitting right on its 50-day trend line.

Contrast that with the chart you’re about to see that shows the Nasdaq 100 Equal Weight Index with its 50-day simple moving average. You’ll notice that today’s prices are well-above the trend line.

This is telling us that, on a relative index basis, the average tech stock has recently been outperforming the average S&P stock. In other words, there’s greater uniformity of strength within the tech sector than the broader S&P.

Now, that said, even within tech there’s been a recent divergence we should note.

***July saw some distancing between tech’s leaders and average tech stocks

Even though the Nasdaq 100 Equal Weight has been outperforming the S&P Equal Weight, we are seeing some divergence within tech stocks.

To illustrate, let’s look at the Nasdaq 100 Equal Weight Index compared to the normal Nasdaq 100 Index.

Below, notice how these two indices moved in lock-step with one another through late June. But this month, we’ve seen the Equal Weight begin to trail the weighted index (circled below).

This means the mega-cap tech market leaders have distanced themselves from the “average” Nasdaq 100 stock.

But, there’s good news this week…

The rally since Tuesday has seen the Equal Weight Nasdaq 100 Index largely keep pace with the weighted Nasdaq 100. This is exactly what we want.

You can see this below with the green line being the Equal Weight Index. Though it’s trailing a bit here in Friday’s trading session as I write, the two indices were neck-in-neck on the week when we opened this morning.

Plus, it’s the same thing over in the S&P…

Below, you can see how the Equal Weight S&P is almost identically tracking the regular S&P.

This is a sign of uniform market strength.

***What all of this means and doesn’t mean

It’s important to note that recent, medium-term divergences in the S&P and the Nasdaq don’t mean we’re on the verge of a dramatic market pullback.

To illustrate, look below at the S&P 500 Equal Weight Index dating back to June 1, 2020. I’ve circled the period from mid-September 2020 through mid-November 2020. It’s similar to what we’re seeing today, with two plunges beneath the 50-day simple moving average, that resulted in a flattening of the moving average.

But as you can see, not only did the S&P not roll over, it soared to end the year.

But…this breadth issue is worth keeping your eye on.

So, over the next couple of weeks, we’ll be watching to see whether the S&P Equal Weight Index continues climbing back above its 50-day trend line…or falls below it. We’re betting on strength, so for now, stay long. If something changes, we’ll let you know here in the Digest.

Have a good evening,

Jeff Remsburg


Article printed from InvestorPlace Media, https://investorplace.com/2021/07/how-strong-is-the-market-really/.

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