Rising interest rates can help the stock market over the short- to intermediate-term because it implies economic strength. It also causes some money to rotate out of falling bond prices and into stocks. Although rising bond yields usually cause problems for the market eventually, we have to watch the market indexes and certain technical indicators to spot when that's happening. One of those is the NYSE Advance-Decline line as shown in Chart 1. As of right now, the AD line is still rising. Historically, the AD line has peaked either before the market or coincident with it. The fact that it's still rising tells us the market's uptrend is still intact. And it will remain intact as long as the NYSE AD line stays over its 50- and 200-day moving averages. Another sign of strength is coming from small cap stocks. Chart 2 shows a ratio of the Russell 2000 Small Cap Index divided by the Russell 1000 Large Cap Index. The ratio has just broken out to a new high. That shows continued leadership in small caps. One of the usual early signs of a market top is underperformance by riskier small caps as money rotates to the relative safety of larger issues. That may happen during the second half of the year -- and I suspect it will -- but it hasn't happened yet. In reality, Charts 1 and 2 are linked. There's a correlation between the direction of small cap stocks and the AD line. That's because there are more small stocks than larger ones. Weakness in small stocks is usually one of the main reasons that the advance-decline line starts to weaken. Right now, small cap strength is helping keep the AD line in an uptrend.
