Timing Models – Small-caps and Finance Sector Perk Up as Breadth Indicators Show Broadening Participation

Stocks surged the last two weeks with a new group of leaders. Mid-caps, small-caps, banks and utilities led the charge. Large-caps and tech stocks lagged, but they still gained and remain bullish overall. The period from late May and early June was the last time we saw small-caps and banks take the lead. After an 18% advance in SPY and 31% surge in IWM, stocks rested from June 8th to July 9th with consolidations.

The current surge remains a work in progress and has yet to match the surge from May 14th to June 8th. The sudden change of heart towards small-caps and banks is quite amazing. Note that Healthcare (21.18%) and Industrials (15.25%) are the two biggest sectors in the Russell 2000 ETF. Finance is third at 15% and Consumer Discretionary comes in fourth at 13.59%. Thus, the surge in small-caps is not just about banks and appears much broader.

SPY Holds Breakout and Follows Through

After exceeding its 40-week SMA by more than 10%, SPY fell just over 10% with a decline that retraced less than a third of the March-September advance. This decline formed a falling wedge on the daily chart and a 3-5 week candlestick reversal formed on the weekly chart. The black candlestick extended the pullback, the indecisive candlestick three weeks showed firming and the surge the last two weeks confirmed a reversal.

The next chart shows SPY with RSI(14) and the Price Oscillator (5,200), which measures the percentage difference between the 5-day and 200-day SMAs. The green shading shows when RSI is in the 30-50 zone (pullback oversold) and the 5-day is above the 200-day (long-term uptrend). Five times since 2018, RSI flirted with the 30-50 zone for three to four weeks and then broke out of a corrective pattern. Once the corrective period lasted 1-2 weeks and the other occurrence was in February-March 2020 (red arrows). The current correction fits the norm of past corrections and ended with the 28-Sept breakout.

So what about that correction theory based on the ROC Shock? Well, this is the challenge when predicting price movements instead of following signals. A corrective period is still possible because the ROC Shock linkgers, but this breakout is getting legs as participation broadens (see breadth analysis below). There was a clear change in the markets over the last two weeks as small-caps and mid-caps started leading and participation broadened into the finance sector. At this point, the falling wedge breakout is the current signal in play and it is bullish until proven otherwise. The breakout zone marks first support at 328.

MDY and IWM make a Statement

The S&P MidCap 400 SPDR (MDY) and the Russell 2000 ETF (IWM) surged over 11% the last 11 days and exceeded their August-September highs. Note that SPY and QQQ remain below their early September high. This means MDY and IWM are showing relative strength now and are poised to make a run towards the February highs. IWM is the closest to a new high (~4.5%) and IJR is the furthest (~10%). The about face the last two weeks is extraordinary because all three were below their 200-day SMAs on September 23rd and lagging.

Breadth Indicators Capture Broadening Participation

There is no change to the breadth models, but we saw a marked improvement in breadth over the last five days. Namely, there were breadth thrusts in the S&P 500, S&P 100, S&P MidCap 400 and S&P SmallCap 600 (10-day EMA of AD% above 30%). This shows strong upside participation during the two week advance and supports the rotation to mid-caps and small-caps. Speaking of, there were two new bullish signals for mid-caps and one new bullish signal for small-caps. All-in-all, breadth is bullish and supports the current bull market environment.

You can learn more about the breadth model and its historical performance in this article and video (here).

New Highs for Cycle and Breadth Thrusts

S&P 500 breadth improved considerably with the %Above 200-day EMA exceeding 70% for the first time in this cycle (March to October). We also saw new highs expand as High-Low Percent exceeded +10% for the first time since 2-Sept and a breadth thrust as the 10-day EMA of AD% surged above +30%. These are not new bullish signals because the model has been net bullish since July 20th and all five indicators have been on bullish signals since 7-Aug.

Nasdaq 100 breadth is lagging a little because High-Low Percent did not exceed +10% and the 10-day EMA of AD% fell short of a breadth thrust. Nevertheless, the long-term model has been bullish since 20-May and the short-term model has been bullish since 29-Apr. The Nasdaq 100 may not be leading the last two weeks, but it is not exactly weak.

S&P 100 breadth improved because non-techs took the lead the last two weeks. The model signals are unchanged because both were already bullish. We saw %Above 200-day SMA near 70% and %Above 150-day SMA exceed 80%, both new highs for the cycle (March to October). New highs expanded as High-Low Percent exceeded 10% and the 10-day EMA of AD% triggered another breadth thrust with a move above 30%.

S&P MidCap 400 Breadth stole the show this week with two new bullish signals, and a confirming breadth thrust. The %Above 200-day SMA moved above 55% to turn bullish. This means four of the five indicators in the long-term breadth model are bullish. We also saw the 10-day EMA of AD% move above +30% twice in the last five days. This shows strong upside participation in mid-caps. It is also worth noting that %Above 20-day SMA surged above 90% to reverse its bearish signal. Even so, the short-term model remained bullish throughout September and all three indicators are on active bullish signals.

S&P SmallCap 600 breadth also improved with the %Above 200-day SMA triggering bullish for the first time since late February. With this signal, four of the five long-term indicators are bullish and the long-term model is +3. Also note that %Above 150-day SMA moved above 70% and hit its highest level since January and the 10-day EMA of AD% surged above 30% for a breadth thrust.

You can learn more about the breadth model and its historical performance in this article and video (here).

Finance Joins the Big Six in Sector Breadth Model

There were three new signals on the Sector Breadth Model and one sector flipped from net bearish to bullish. All told, 10 of the 11 sectors are net bullish. XLE is the only sector net bearish and XLRE is the least strong of the bullish sectors. 28 of 33 signals are bullish and this supports the bull market in the S&P 500.

The Finance SPDR (XLF) is one of the six biggest sectors and it was the big laggard. This changed as the 10-day EMA of AD% surged above 30% and %Above 200-day EMA exceeded 60%. These two also triggered bullish in early June and the bullish signal resulted in a whipsaw. On the price chart, XLF remains stuck in a consolidation. A breakout and move above the Aug-Sep highs would confirm the bullish breadth signal.

Yield Spreads and Fed Balance Sheet

The AAA bond spread edged lower the last two weeks and remains below the pre-crisis high. Current levels have been indicative of a normally functioning debt market since early June and this took away a negative for stocks. BBB spreads moved below their pre-crisis highs in early July and remain at normal levels.   

Junk bond spreads ticked lower the last two weeks, even more so than the investment grade spreads. Junk bonds are more sensitive than investment grade bonds and the narrowing of spreads is bullish for stocks. The narrowing means the yield on junk bonds moved closer to the yield on Treasury bonds. Both spreads are below their pre-crisis highs and reflect normally functioning debt markets.

The Fed balance sheet expanded this past week and the slow expansion since mid July continues. Overall, the balance sheet remains above $7 trillion and the Fed has yet to take away the punch bowl. Watch out because Congress may be set to spike the punch with more stimulus, this year or next.  

Thanks for tuning in and happy Friday!

-Arthur Hill, CMT
Choose a Strategy, Develop a Plan and Follow a Process

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