While everyone else is watching the Russell 2000 index falling below its 200 day moving average again today I’m watching the ratio between the S&P 500 Equal Weight Index (SPXEW) and the S&P 500 Index (SPX). It is another way to compare small cap stocks to large cap stocks. When this ratio is falling it shows that smaller stocks are not performing as well as large caps and that rotation from small to large is likely under way. When the ratio falls below its 20 week moving average (on a weekly basis) the market generally gets choppy or declines over the next several weeks. If it happens this week then it’ll be one more warning on top of all our other indicators signalling now is a time for a bit of caution.
Over the past week our market health indicators held up while the perception of risk subsided. Our measures of market strength fell the most, but are still showing very healthy readings. With little concern for risk and strong underlying internals the market is free to move higher. All it needs is a reason. One of the things I’ve been mentioning over the past few months is the move to larger stocks (perceived as safe). That condition often precedes market declines. Comparing the S&P 500 Equal Weight index (SPXEW) to the S&P 500 index (SPX) highlights the move. When the ratio between SPXEW and SPX falls below its 20 week moving average it often marks short term tops. It was something I’ve been watching as an early warning sign, but that condition has now been cleared. It’s an example of how resilient the market currently is. Below is a chart that represents our core health indicator categories. With all of them above zero our portfolios remain 100% long.
Here are a few things I’m currently watching to provide more early warning that the current draw down might get serious. The Cumulative Advance Decline line (NYAD) is probably the most important since it has provided good guidance all year. Remember when everyone was calling a top in September because of the negative divergence? I pointed out that it was painting a triangle and that the break would point the direction for the market. NYAD broke higher and the market rallied. Now NYAD is starting to roll over in a more serious way, however, it is still above the trend line created from the bottom of the previous triangle. As long as it stays above that level and the previous two valleys the market will most likely catch and drift higher into the end of the year. A break below those levels will get me concerned. As a side note, there are now several people mentioning the percent of stocks above their 200 day moving average diverging from price and