Breadth is a big sign in helping determine whether a market trend is continuing or reversing. Usually the generals (large caps) and the troops (small caps) trend in the same direction. When they don’t, as is the case currently, it can be a sign of potential change to come.
The chart above comparing trading action in the broad based US Small Cap 2000 index versus the narrow large cap US 30 index shows that for most of the last six months, the two indices have been trending together, but the two times that they diverged were near significant turning points.
Back in October, the generals did not confirm a selloff in the troops just before everything reversed and rallied. In the last month, continued gains in the US 30 have not been confirmed by gains in the US Small Cap 2000. This indicates that advances have been concentrated in a small group of large cap stocks a sign of weakening breadth and the growing potential for a correction.
Additionally, the RSI indicator for the Small Cap 2000 indicates that upward momentum has been slowing for some time. The recent peak above 1,400 not only failed to hold, it also was not confirmed by the RSI, both signs of technical momentum exhaustion.
Signs of distribution in the US Small Cap are starting to emerge including a lower high for the index near 1,395, but also the RSI indicator falling toward then under 50 and remaining in a downtrend even on a recent rebound. Next potential support for the Small Cap appears near 1,345 then 1,310. Meanwhile, the big cap US 30 index looks increasingly at risk of its consolidation phase turning into a deeper correction.
One of the reasons that the recent rally may be running out of gas is that we may be running out of something new to drive the market higher in the near term. The big post-election rally was built on unrealistic speculation that President Trump would introduce new policies and reforms that would provide an immediate boost to the US economy, be introduced smoothly and with limited turmoil or opposition.
With President Trump’s initial budget request now out, earnings season long over and health care reform working its way through Congress, the rubber is starting to hit the road, traders going forward may spend more time reacting to what happens rather than hoping for the best. Because Trump has been priced to perfection, it wouldn’t take much of a hiccup to upset this apple cart. Even the lack of news, any sign things could take longer than hoped could cause bulls to lose patience.
This week, the main focus is on Fed speakers, including chief Janet Yellen. The market saw last week’s FOMC statement and dot plot as very dovish, calling for three hikes this year rather than the four that had been priced in so this week. I think though that the Fed is only calling for three because they want to have flexibility is case there is a big showdown over the budget and debt ceiling, so this week, we could see speakers try to recalibrate expectations.
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