A Growing Divergence in Performance for the S&P 500 Components

As we approach the final days of April, if you were to look back and try to put your finger on a theme for the last four months, one that you may select could be the growing divergence taking place in the S&P 500. What I’m referring to is the separation in performance that appears to be taking place among the largest of the S&P 500 stocks and the less large (smaller?) stocks that round out the index. Eyeing a long-term chart of the equity market there appears to have been a couple previous examples of this taking place, I’ll get into those later. First let’s look at present day…

Below is a chart of the S&P 500 Index (red line) and the ratio between the S&P 500 Equal weight ETF ($RSP) and the S&P 500 ETF ($SPY) which is cap-weighted. (yes I could have used the indices but I, no big reason why I chose not to. I just naturally gravitate to ETFs). I tweeted out this chart yesterday but I wanted to provide a little more commentary to what’s taking place.

When the Black line is rising that is telling us that the Equal Weighted $RSP is rising more (or falling less) than the cap-weighted $SPY, and when it’s declining the opposite is taking place. The latter is what we are seeing play out so far in 2017 with the largest of the S&P 500 components leading the charge higher.

Another instance we saw this play out was in 2012. During the initial bounce off the low in May we saw the S&P 500 begin making higher lows but it was being done on the backs of the largest components – as we can see with the black ratio line making lower highs from May through August. This divergence was ultimately responded with the market as a whole heading to new highs and the smaller S&P companies once again taking the lead.

The reason that we may attention to which parts of the market are leading and lagging is because it provides insight into the level of risk taking that’s occurring within the market. It’s commonly believed that the larger the company’s market cap, the less riskier the stock (obviously there’s plenty of examples of this not being 100% true all the time). When the market is trending higher many bulls want to see the more riskier portions of the market, such as small caps and mid caps show strong relative performance. And one way we can measure that is by looking at which parts of the S&P 500 are showing that relative performance – the largest weighted or the smallest weighted stocks within the index.

Here’s another example a divergence being formed between the two differently weighted ETFs. Let me first say, yes this is showing the 2007 peak in stocks before the Financial Crisis. No, I’m not calling for a long-term top in the S&P 500, this is just another example of a similar divergence. As with many major market peaks, the are lead by a narrowing of breadth, also known as participation. This showed up in the lack of relative strength among the smaller S&P 500 stocks in June 2007 through the rest of the year. And we know how that played out in the next twelve months….

So there are two examples of a growing separation in the largest and smallest stocks that make up everyone’s favorite equity index. One (2012) was resolved with the market going higher and another (2007) that led to a major bear market. Which one will we see? No idea, and there’s no reason we must replicate either of these instances.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

CNBC and Investopedia Interviews

The response I’ve gotten back from my research on market volatility has so far been really positive and it’s now in the top 1% of papers downloaded at SSRN, which means a lot to me that so many have had a interest in reading my paper. I’ve also had the opportunity to discuss the Dow Award and my research in a couple interviews, which I’ve linked below.

(On a side note, I promise to get back to writing more on the blog – it’s been more a lack of time than a lack of insights I’ve wanted to share with you guys, so hopefully can start producing more content very soon.)

At the MTA Symposium I spent a view minutes talking with JC Parets of All Star Charts for Investopedia.

I also did an interview with Brian Sullivan for CNBC, discussing my work and some of the resent signals of narrowing dispersion in the volatility index.

Meet the Winner of the 2017 Charles H. Dow Award (Investopedia)
A new method for predicting volatility ‘tsunamis’ (CNBC)

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Forecasting a Volatility Tsunami

Let me first say a huge thank you for all the kind words and messages I’ve received regarding winning the Charles H. Dow Award. This past week was the annual Market Technicians Association Symposium in New York. Traders from all over the world came together to discuss the markets, different strategies and approaches to trading, and some of the new technology that’s being developed around technical analysis. It was also great getting to meet many of you that have been following this blog and/or me on Twitter/StockTwits. I always enjoy getting to learn new ways of viewing the financial markets and getting to discuss new ideas with other traders and asset managers.

Needless to say, it was a huge honor to receive the Dow Award on Friday in front of so many professionals I have such great respect for. I’ve uploaded the paper to the SSRN and I look forward you all getting to read my paper, Forecasting A Volatility Tsunami.

It seems we are inundated with the idea that just because the Volatility Index (VIX) is at a low-level that it will immediately spike higher. I found in my research that there’s a better way to forecast these spikes in the VIX, a better way to identify a market environment that has often lead to large moves in volatility. I liken my findings to the forming of storm clouds, not all clouds lead to rain but nearly all rain storms are preceded by the clustering of clouds. The market environment I describe in my paper doesn’t always lead to spikes in the VIX but nearly all spikes have been preceded by this unique price action pattern found in the volatility market. As a Portfolio Manager and someone who places a great value on risk management, I believe it’s important to know when risks of large volatility spikes are present and I believe my paper lays the foundation for this as well as for further research on the topic to be conducted.

Here is the link to read my full Charles H. Dow Award winning paper: Forecasting a Volatility Tsunami

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.