The WSJ reports,"another day, another record high and another potential cause for concern.
Jonathan Krinsky, chief market technician at MKM Partners, alerted clients Monday of a sharp divergence playing out in the markets. As of late last week, some 80% of S&P 500 components traded above their 200-day moving averages—a proxy chart watchers use to gauge a market’s long-term trend.
The fact that so many companies traded above this technical indicator is a positive sign, suggesting wide participation among the market’s rally.
At the same time, only 42% of Russell 2000 small-cap stocks traded above their 200-day averages, a sharp contrast from the S&P 500. In fact, it marks the widest divergence between the two indexes since 1995, according to Mr. Krinsky’s calculations.
It’s unclear what the ramifications of this divergence suggest for the broad market’s next move, although the trend is an oddity that is gaining attention among market watchers".
"The departure between the Dow and S&P 500, which hit new records Monday, and the Russell 2000 is hardly surprising. Small-cap stocks have fallen out of favor in recent months as investors flocked to larger, dividend-paying and more attractively priced companies. The Russell 2000 Friday briefly tumbled on an intraday basis into correction territory, Wall Street parlance for a 10% drop from a recent high.
“What we have seen over the last few weeks is unprecedented in at least the last 20 years,” Mr. Krinsky said.
He outlined three instances–1995, 1999 and 2007—in which the market experienced similar—albeit not as extreme—divergences.
In 1995, stocks were in the middle of a secular bull market. The divergence between the Russell and the S&P 500 didn’t matter much as both kept rallying in lockstep through that summer. The rally ultimately continued for several years before topping out.
In early 1999, the tech bubble was in full blast just as the components in the S&P 500 and Russell 2000 were diverging. The Russell dropped about 10% that year from late-January to mid-February 1999, while the S&P 500 was relatively unchanged over that same period. “Not too dissimilar from what has happened recently,” Mr. Krinsky said. “Ultimately this was resolved with both indices moving higher for the next year, before both peaked for good in March 2000.”
And finally in 2007, the divergence between the two indexes ultimately provided a strong warning sign that the overall market was getting top heavy. Both the Russell and the S&P 500 slumped from May through July of that year. The S&P 500 recovered and made a new high in October, while the Russell lagged. Both ultimately fell in the months leading up to the recession.
In other words, three similar market divergences led to three very different results, making it difficult to glean any significant takeaways from the market’s latest moves.
Sure enough, many of the beaten-down momentum stocks jumped on Monday. The Russell 2000 rose 2.4%, its biggest gain since March 4. The tech-heavy Nasdaq Composite increased 1.8%. It sits less than 1% from turning positive for the year".
But one day doesn’t make a trend. And Mr. Krinsky says he will remain guarded about the market heading into the summer.
“Nobody knows for sure which way the present market will resolve itself, but given the sector action we have been seeing, we remain on the cautious side until proven otherwise,” he said.
