SMALL-CAPS AND LARGE-TECHS LEAD YEAR-TO-DATE -- JANUARY BAROMETER BODES WELL FOR STOCKS -- CORRELATION TURNS POSITIVE FOR STOCKS AND TREASURIES -- CORRELATION TURNS NEGATIVE FOR STOCKS AND OIL -- CRUDE OIL REMAINS WITHIN FALLING WEDGE
SMALL-CAPS AND LARGE-TECHS LEAD YEAR-TO-DATE... Link for todays video. Before looking as small-cap performance, lets distinguish between the January barometer and the January effect. The January barometer refers to the historical tendency for January performance to set the tone for the entire year. As January goes, so goes the rest of the year. The January barometer was devised by Yale Hirsch and popularized in the Stock Traders Almanac, which is published by Jeffrey Hirsch and Yale Hirsch. This indicator has worked 89 percent of the time since 1950. The January effect, which is a close cousin, refers to the historical tendency for small-caps to outperform large-caps in the month of January.
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Chart 1
Chart 1 above price performance for five major index ETFs this year. The Nasdaq 100 ETF (QQQ) and the Russell 2000 ETF (IWM) sport the biggest gains (>9%). QQQ represents large tech stocks (think Apple), while IWM represents small-caps. The S&P MidCap 400 SPDR (MDY) is a close third with a year-to-date gain just under 9%. The two large-cap ETFs, the Dow Industrials SPDR (DIA) and the S&P 500 ETF (SPY), are bringing up the rear. Even so, their year-to-date performances are nothing to sneeze at. Relative strength from small-caps is a good sign for the market overall. Smaller companies are less diversified and more dependent on the domestic economy. Relative strength in small-caps bodes well for the US economy and this in turn bodes well for the stock market overall.
JANUARY BAROMETER BODES WELL FOR STOCKS... Chart 2 shows the S&P 500 moving higher throughout January and exceeding 1320 on Wednesday. Historically, a strong performance in January indicates that the year will finish strong. This benchmark index broke the 200-day moving average and resistance in late December. Also notice that the 50-day SMA moved above the 200-day SMA this week, which is known as a golden cross. Even though the bulk of the evidence remains bullish, keep in mind that moving averages lag and this golden cross is a lagging signal. I think the late December breakout was the last important signal on this chart. Broken resistance and both moving averages combine to mark first support in the 1260 area. With the index overbought and the first of the month behind us, we could see a correction back to this breakout. The indicator window confirms overbought conditions as 14-day RSI moved above 70 last week and remained a relatively high levels this week. Chart 2 shows the Nasdaq breaking resistance in early January and nearing its 2011 highs with todays surge.
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Chart 2
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Chart 3
Before moving on, I would like to share some information on the first trading day of the month, which has had a bullish tendency for over 20 years. Many different analysts have quantified this tendency over the years. In his Chart in Focus on September 30th, Tom McClellan (mcoscillator.com) notes that the S&P 500 closed higher 65.7% of the time on the first day of the month (since January 2003). McClellan further breaks down the statistics to show that the first day of the month has an even greater bullish tendency when the trend is up, which is when the S&P 500 is above its 200-day SMA. Furthermore, the gains from the first day of the month outperformed buy-and-hold from January 2003 until September 2011. S&P 500 performance sags significantly when the gains from the first trading day of the month are removed. It is, therefore, important to capture these one day gains. Keep this in mind before chasing the market higher
CORRELATION TURNS POSITIVE FOR STOCKS AND TREASURIES ... Even though the major stock indices remain in uptrends, there are some puzzling developments in the intermarket arena. Stocks and treasuries have been negatively correlated most of the last twelve months, which means they move in opposite directions. This negative correlation is being challenged over the last few weeks as both move higher. Something needs to give here. Either stocks reverse their advance and treasuries continue higher or treasuries reverse their advance and stocks continue higher. Chart 4 shows the 7-10 year T-Bond ETF (IEF) breaking above its 2011 highs with a surge above 106 last week. After consolidating near these highs for several weeks, the ETF broke out with a surge the prior seven trading days. IEF fell back today, but forged a new 52-week high nonetheless. First support is based on the late January low at 104. Key support is based on the early December low at 103.
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Chart 4
The indicator window shows the Correlation Coefficient for the 7-10 year T-Bond ETF (IEF) and S&P 500 ETF (SPY). Correlation was briefly positive from late April to mid May and then negative until mid January. More recently, the Correlation Coefficient moved into positive territory twice in the last few weeks. This means both stocks and treasuries were strong. I would not expect these two to move in the same direction for an extended period. Chart 5 shows the 10-year Treasury Yield ($TNX) testing its December lows and the Correlation Coefficient on the verge of turning negative. Keep in mind that treasuries and yields move in opposite directions. Therefore, stocks have been positively correlated with treasury yields.
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Chart 5
CORRELATION TURNS NEGATIVE FOR STOCKS AND OIL ... While stocks and treasuries have been negatively correlated, stocks and oil have been largely positively correlated. This makes sense for two reasons. First, stocks and oil are positively correlated because both are dependant on the economy. A strong stock market points to a strong economy and this points to increased demand for oil. Second, oil and treasuries are negatively correlated because strength in oil points to inflation, which is negative for treasuries. Chart 6 shows Spot Light Crude ($WTIC) in black and the S&P 500 in red. The S&P 500 continued its advance in 2012, but crude turned lower and moved down this year. The indicator window shows the Correlation Coefficient turning negative and moving to its lowest levels since March 2011. The decline in oil is disconcerting for stocks because oil peaked in early May 2011 and started underperforming the stock market just before the July-August plunge. Even though correlations sometimes get out of whack for a few weeks and then fall back into place, chartists should keep a close eye on these deviations because they could foreshadow other reversals.
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Chart 6
SPOT LIGHT CRUDE REMAINS WITHIN FALLING WEDGE... Chart 7 shows Spot Light Crude ($WTIC) backing further off resistance and closing below 100 this week. On Friday I wrote about the inverse head-and-shoulders pattern and falling wedge. These patterns remain in play and crude remains short of a breakout. I am marking wedge resistance at 101.50 and neckline resistance at 104. Should these patterns fail to pan out, chartists should then consider the possibility of a double top with support at 92.50. The indicator window shows the Price Relative ($WTIC:$SPX ratio) falling since late November. This means crude has been underperforming the stock market for over two months. No wonder the Energy SPDR (XLE) is having trouble with its triangle breakout.
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Chart 7
