Friday, April 19, 2013

The Pattern That Is Developing

One of the oldest axioms on Wall Street is that the market redistributes wealth from the many to the few. It will, in other words, fool the most. Keep that in mind as you read further.

We have previously noted how 2013 appears to be, in many ways, a dead ringer for 2011, a year in which SPX started very strong, following on the heels of a great market in 2010, then proceeded to trade sideways in a 10% band for 5 months. Sentiment, fund lows, sector rotation, ex-US markets and junk bonds have all behaved very similar between the two years. Catch up with this analogy here.

We've also noted the recent pattern in the market, shown in the first chart below. After a long uptrend (blue line), the upward momentum begins to wane, the trend line is breached and trading becomes choppy, with break downs and break outs failing (yellow areas). By appearances, SPX is starting to repeat this pattern now. Having said that, re-read the first paragraph above.

What lends some credence to the pattern playing out again is that we are seeing it in other markets and sectors.

Start with the small cap index, which had led through 1Q but is now lagging SPX. After breaking trend in March, it touched its 50-d and then rallied to its prior high, reaching its first Bollinger (20,1) before selling off again. The action confounded many. It has made no net progress since early February.

Next look at transports. Same pattern: broke trend in March, bounced off its 50-d then rallied to its first Bollinger.  As of today, it has made no net progress since the first day in March.

Semiconductors, which generally lead the tech cycle, have the same pattern, breaking trend in February with no net progress in more than two months.

Leading growth companies like Amazon are similar. Amazon is, in fact, flat for all of 2013.

Nasdaq overall is starting to display this pattern. It looks like it is a step behind small caps and a step ahead of SPX, as you would expect. That has clear implications for SPX if this holds true. A rally to the prior high (or first Bollinger) after reaching its 50-d yesterday might well ensue for SPX. Re-read the first paragraph above.

The loss of momentum is not limited to a few companies. Overall, whether looking at SPX or Nasdaq, the percentage of companies trading over their 50-d is in clear decline.

Outside of US markets, we see a similar pattern. Below is a chart of the Euro 350 index. The All World Ex-US index (not shown) is the same. Recall that markets globally tend to move together over time.

No doubt a new surprise is in store for us. But for now, this is the pattern you might keep in mind when looking for an edge.