Broker Check
A Temporary Pause May be Needed

A Temporary Pause May be Needed

| August 26, 2020

The market rally off the March 2020 low has been stunning to say the least. It has mostly been a technology led rally with the top 5 largest stocks doing most of the heavy lifting. Rey Descalso and I have touched on this multiple times in previous blogs.

The market has done nothing wrong since March and has continued to grind higher. However, I am beginning to see some developments on the charts that have me believing the market is likely to pause soon and digest some of these gains. Last week, while the market pushed higher, many market breadth measures did not confirm the move. The NYSE advance-decline line moved lower each day last week as the market moved higher. This can be seen in the chart below, depicted by the arrows. This shows that more stocks on the NYSE were declining than advancing last week.

The percentage of new 6-month and new 12-month highs on the NYSE has also trended lower during the most recent push higher in the market. This is labeled on the chart below with arrows. This does not mean the market won't continue to advance over the long term, but it may need time to pause and reset.

This has been a large cap rally for the most part. We have had days of rotation into small and mid-cap stocks, but nothing that has lasted for any extended period. Pictured below is a chart of SPY (S&P 500), RSP (Equal-weighted S&P 500), MDY (S&P Midcap 400), and IWM (Russell 2000).  We can see that although SPY has pushed to new all-time highs, other areas of the market haven’t been nearly as strong. The equal-weighted S&P 500 (RSP) is still below its all-time high and has struggled to break above its most recent peak made back in June. Likewise, MDY and IWM are also weaker and continue to struggle around their prior high made in June. Furthermore, last week as SPY pushed higher, many other areas of the market pulled back. This is noted in the charts below with arrows.

Source for all charts: Optuma

The most recent market action reminds me of a well-known rule from Wall Street legend Bob Farrell. "Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names." Meaning, breadth is important. The strongest rallies are those that have broad participation, not just one sector or a handful of stocks. A market pause and pullback, with rotation into other sectors, would be a healthy development in my opinion. If you would like to discuss further, click here.

The indexes mentioned in this communication are unmanaged and not available for direct investment. Past performance is no guarantee of future results. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information contained in this commentary has been obtained from sources that are reliable. This presentation is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.