A shift in dynamics in the nation's capital has pushed the S&P 500 index to new highs. But, can the market follow through on its breakout? Also, many thanks to all who wrote in with a solution to my last week's puzzle (more on that below).
Chart 1: The S&P 500 Index and the Dow 30 topped my trend strength rankings after many months, as the market signals a willingness to go higher.
Market New Highs in 2017 have Been Followed by Selling
I used my short-term trend-following model (a 5-day simple moving average coupled with half-width 25-day Bollinger bands) to calculate the percentage of S&P 500 stocks trending higher throughout 2017 (see Chart 2). The blue line is simply a flag, rising to 1 for each new 200-day high. As I show below, significant selling has kicked in after new highs, and other than the move in February, the market has not followed through, i.e., the 20-day return after each new high has fallen throughout 2017 (see Chart 3). A chart of the S&P 500 with a 200-day channel confirms the analysis in Charts 2 and 3 (See Chart 4).
Chart 2: The red line shows the fraction of S&P 500 stocks trending higher on my short-term model. The blue line moves to 1 for each new 200-day high. After the surge in February, new highs have triggered determined selling in the S&P 500 stock universe.
Chart 3: After the surge in February, the follow through after new highs, measured as the subsequent 20-day return, has diminished consistently through the year. In other words, there has been little follow through after new highs, consistent with the selling visible in Chart 2.
Chart 4: After the February surge, the market has been unable to sustain a major breakout, with selling on the heels of new highs. So, the question now is whether the market can follow through on the most recent breakout.
Market Repairs its Internals
The bulk of the selling in August was in value stocks, and mid-to-small capitalization stocks. For example, the Russell 2000 was the weakest of the major indexes, as shown in my previous posts. I have written about the small cap selling in detail in my previous posts.
Note in Chart 5 (Vanguard Small-Cap Value ETF) and Chart 6 (Vanguard Mid-Cap Value ETF) how these stocks have essentially moved sideways all year long, but have rebounded smartly in the most recent bounce to new highs in the major averages. The selling in mid-and-small cap stocks was clearly more intense during August than in mega cap stocks (compare Charts 5 and 6 to Chart 7).
Chart 5: The small cap value stocks have moved sideways all year long, and faced serious selling in August. However they have bounced in the run up to new highs in the S&P 500.
Chart 6: Mid Cap value stocks chart look much like their Small Cap cousins.
Chart 7: The sell-off in Mega Cap stocks was muted when compared to Small and Mid Cap stocks in August. For example, the 10-day simple moving average remained above the 50-day simple moving average for MGK in August, unlike in charts 5 and 6 above.
The NYSE Composite and Semiconductors Breakout Is a Hopeful sign
It is helpful that the very broad NYSE Composite index has also rallied to new highs along with the S&P 500 index. The semi-conductor stocks have been consolidating for the past three or four months, but also rose to new highs. The strength in the small-and-mid cap stocks, plus strength in the very broad NYSE index, and rejuvenation in chip (i.e. technology) stocks is a hopeful sign that the market can follow through in a meaningful way.
Chart 8: The NYSE composite index has rallied to new highs, suggesting that the broad market is in sync with the narrower indexes.
Chart 9: Semiconductor stocks led and sustained their rally perhaps longer than any other group, and had been consolidating since June. Now they too are breaking out to new highs, supporting the rally.
Solution to Last Week’s Puzzle
I would like to thanks all who commented or emailed me with their solution to my last week's puzzle. I hope you enjoyed a little sleuthing on the side. The solution is below. Naturally, we all have our own favorites, but they are all highly correlated, something that is not immediately obvious if one were to look through the provenance, but not that unusual either.
Chart 10: The three indicators I show cased were the KST, PMO and MACD. Though they have different provenance, and separate scales and weights, they are highly correlated across all time frames.
Ideally, the market will follow through on its most recent breakout, as the shock-value of Asian headlines has declined, and legislative deadlines have been shifted to year end. As the tone changes in Washington, perhaps the market can change its tune at new highs.
Thank you for looking in, and I hope you liked the more quantitative take on recent market moves. Please subscribe to the blog using the quick link below.