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. The important takeaway is the acknowledgement that the largest companies in the index are what have been leading it higher – that’s where bulls seem to be concentrating their efforts.

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.

Are Semiconductors Warning of Future Tech Sector Weakness?

Back in 2014 I wrote a post (which Bloomberg picked as their Chart of the Day) outlining how semiconductors had replaced copper as the new barometer for the market. For quite a while copper was thought to have had a PhD in economics, as its price movement acted as a good indicator of economic activity. As the U.S. (and the global) economy shift to be more technology-focused, semiconductors took over at head of the class.

With the prominent use of semi’s in the tech space, they become an obvious tool to be used in evaluating the technology sector. Below is a chart showing the relative performance ratio between semiconductors ($SMH) and the S&P 500 ($SPY), with its respective Relative Strength Index (RSI) in the top panel.

Over the last several years when momentum, as measured by the RSI, diverges (making a lower high as the ratio between $SMH and $SPY makes a higher high), a trend reversal often follows as semiconductors begin to under-perform the overall U.S. equity market. This has also led to lackluster performance by the tech sector ($XLK) as well. In the bottom panel of the chart we have the ratio of $XLK and $SPY, and when $XLK is outpacing $SPY (by either going up more or going down less) the line rises.

The opposite is also true, when momentum for the $SMH and $SPY ratio creates a positive divergence, as it did in February of this year and August of last year, the tech sector’s trend in under-performance has reversed.

Since early November, semiconductors have seen a strong performance. and recently the ratio between semi’s and the S&P 500 made an attempt to break to a new high, surpassing its prior October peak. However, the breakout was accompanied by a bearish divergence in momentum and as of this writing, has failed to hold. This false breakout and bearish divergence creates a poor environment for $XLK, as its relative performance often mirrors that of semiconductors. I think it’s also important to note that while the $SMH-$SPY ratio got back to its prior October high, the $XLK-$SPY ratio did not, an additional sign of technology weakness.

smh-spy

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.

The Relationship Between Stocks and Bonds Remains in a Range

Miss me? I haven’t been as active on the blog as I would like but I still share quite a bit on Twitter and StockTwits, so make sure follow me there to keep up with my insights and charts. Anyway, let’s get into it…

We are close to finishing out the historically bearish period of seasonality for equities and while we didn’t see any kind of crash that many traders were hoping for expecting, the S&P is up nearly 4% and saw just a 5% drop back in June. Overall, not a terrible summer when all things considered.

The chart I’d like to discuss today is of the weekly un-adjusted (not accounting for dividends) ratio between the S&P 500 ($SPY) and 20+ Year Treasury Bond ETF ($TLT) over the last seven years. As a reminder, when $SPY is outperforming $TLT the line rises and when the opposite happens the line declines, this doesn’t mean equities are appreciating, it simply shows which data set is rising more (or falling less) than the other.

I think it’s important to monitor the relationship between stocks and bonds and that’s exactly what this chart helps us do. The ratio between these two markets has been in somewhat of a range since late-2013 as it has been unable to produce a meaningful new high or lower lows. This creates a consolidation triangle pattern that we can view as levels of support and resistance with regards to the relative performance of $SPY and $TLT.

As the chart below shows, the ratio has found prior support at 1.45, which if broken could see a decline down to 1.35 which is the last significant area of price memory (2010 turning point and 2013 slight decline). On the upside we have a declining trend line connecting the lower highs since 2015. A break here could see $SPY outpace $TLT with the ratio rising back to its prior high around 1.80. To better gauge a break of either resistance or support (one will eventually have to happen whether it’s due to pacing of time or price movement) I’ll evaluate trend strength (not shown on chart) to better understand the potential the break has ‘staying power’ and the potential of a false break or reversal. But at this point, we have our levels and can be patient, allowing the market to dictate a bias.

stocks-vs-bonds

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.