DOW INDUSTRIALS JOIN TRANSPORTS IN RECORD TERRITORY -- S&P 500 NEARS TEST OF 2000-2007 HIGH -- SMALL AND MIDSIZE INDEXES HAVE ALREADY HIT NEW HIGHS -- SO HAS THE S&P 500 EQUAL WEIGHT ETF WHICH GIVES BIGGER WEIGHT TO SMALLER STOCKS
DOW INDUSTRIALS JOIN TRANSPORTS AT RECORD HIGHS... The ability of the Dow Industrials to rise above its 2007 high to reach a new record is certainly a positive development for the stock market's long-term trend. The monthly bars in Chart 1 show the Dow Industrials trading above their October 2007 peak. Since this is a monthly chart, the Dow needs to stay above 14198 for the remainder of the month for the breakout to be valid. But the trend points in that direction. Also encouraging is the fact that the Industrials have now joined the Dow Transports in new high ground. The upper bars in Chart 1 show the Dow Transports reaching a new record high during January. We pointed out at the time that the new record by the economically-sensitive transports was a positive sign and increased the odds for a new record by the Industrials. The fact that both Dow Averages have reached new highs is another positive Dow Theory signal.
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Chart 1
S&P 500 IS NEARING TEST OF OLD HIGHS... As encouraging as this week's record high by the Dow Industrials is, I believe the more important test will come from the S&P 500 which is the main benchmark for the U.S. stock market. The monthly bars in Chart 2 show the S&P 500 within 34 points (2%) of a new record intra-day high (based on yesterday's closing price). As I suggested in last Thursday's message, I believe that technical odds favor a new high being reached by the S&P 500. My only concern over the short-term is that the SPX is reaching that test of its 2000-2007 highs in an overbought condition. That's reflected by the fact that the 14-month RSI line (top of chart) is nearing overbought territory above 70 for the first time since 2007. That suggests that some profit-taking is possible around the hold highs. Even if that were to happen, I believe that selling will be temporary. One factor favoring an eventual upside breakout by the SPX is the fact that small and midsize indexes have already reached new highs. Only the largest stocks in the SPX have yet to break out.
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Chart 2
SMALL AND MIDSIZE STOCKS HAVE ALREADY REACHED NEW RECORDS ... Chart 3 breaks down the market into three categories based on size. The two upper boxes show that the S&P Small Cap (SML) and the S&P Midcap (MID) indexes have already reached new records (see circles). The lower box shows the S&P 100 (OEX) still well below its 2007 highs. The OEX represents the largest 100 stocks in the S&P 500. The good news is that the OEX has broken through a thirteen-year resistance line drawn over its 2000-2007 highs. Chart 3 tells us that the current rally is being led by smaller stocks, and that the large caps are still lagging behind. It's usually a sign of optimism when smaller stocks are rising faster than larger stocks, and increases the odds for an eventual upside breakout by the S&P 500 Large Cap Index.
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Chart 3
S&P 500 EQUAL WEIGHT ETF AT A NEW RECORD... One way you can take advantage of stronger small and midsize stocks is through the Guggenheim S&P 500 Equal Weight ETF (RSP). This ETF contains the same stocks in the more traditional S&P 500. The difference is that the S&P 500 is "capitalization-weighted", which gives greater weight to larger stocks. The RSP gives "equal weight" to each of the 500 stocks. As a result, the largest stocks (which are lagging) are given less weight, while the smaller stocks (which are leading) are given greater weight. Of the 10 largest stocks in the SPX, only five have hit new 52-week highs. Another advantage of the RSP is that it's less impacted by drops in some of its largest stocks. The largest stock in the SPX is Apple (3%) which has lost a third of its value. Microsoft has lost 8% over the last year. Those stocks have a much smaller weight in the RSP. The solid line in Chart 4 shows the equal-weight version of the S&P 500 trading at a new record. The gray matter is a relative strength ratio of the equal-weight index (RSP) divided by the cap-weighted index (SPX) since 2007. The chart shows that it's usually a good sign when the RSP is rising faster than the SPX (rising ratio). The ratio turned up during 2009, corrected downward during 2011, and turned up last year. It's still rising which is a positive sign for the SPX. There is a downside to the RSP. During 2007 and 2008, the RSP fell further than the SPX. That's because smaller stocks usually fall further than larger stocks during a market downturn. The good news is that those same smaller stocks usually lead during a upturn, as they've done since 2009.
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Chart 4
EQUAL WEIGHT NASDAQ 100 ETF OUTPERFORMS QQQ... The same analysis in the previous paragraph holds true for the Nasdaq 100 (which contains the largest 100 non-financial stocks in the Nasdaq). The blue bars in Chart 5 show the Power Shares Nasdaq 100 Trust (QQQ) trading at a five-month high, but below its September peak. By contrast, the First Trust Nasdaq 100 Equal Weighted Fund (QQEW) has already cleared that high. The weaker performance by the QQQ is mainly because of its heavy-weighting in big market laggards like Apple, Microsoft, and Intel -- all of which have lost ground since last September. Those three big tech losers account for a quarter (25%) of the QQQ. Apple, which is the biggest QQQ stock (15%), has lost 35% since September. The equal weight ETF (QQEW) has a much smaller weight in those three losing stocks. My January 29 Market Message carried the headline: "Weakness in Big Technology Stocks (like Apple) Masks Much Broader Nasdaq Strength". An equal weighted index for the Nasdaq 100 (like the QQEW) is one way to reduce the negative impact of those larger stocks that are weighing on the QQQ.
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Chart 5
NASDAQ IS LEADING STOCK MARKET OUT OF LOST DECADE... This last headline is also taken from my January 29 Market Message. And it may be the most important of all the charts shown in this message. The monthly bars in Chart 6 show the Nasdaq Composite Index peaking during 2000 and losing 78% of its value by 2002. That 2000 Nasdaq collapse led to an eventual tumble in the rest of the market later that year. The chart shows the Nasdaq in a sideways trading range between its 2002 and 2009 bottoms and its 2007 top (see circles). The good news is that the Nasdaq rose above its 2007 high during 2012 and is still climbing. This week's advance has put the Nasdaq at the highest level since the "lost decade" began during 2000. It seems only fitting that the same index that started a bad decade for stocks appears to be leading the market out of that losing decade. That major bullish breakout by the Nasdaq also suggests that the "secular" bear market in stocks that started during 2000 has ended, and that a new secular bull market may be beginning.
