NASDAQ AND SMALL CAPS LEAD MARKET INTO BEARISH WEEK -- DOW AND S&P 500 TURN DOWN IN HEAVY TRADING -- SECTOR ROTATION REMAINS DEFENSIVE -- CONSUMER CYCLICALS AND FINANCIALS SHOW RELATIVE WEAKNESS
NASDAQ LEADS WEEKLY LOSSES -- DOW HOLDS UP BEST... The relative performance of U.S. stock indexes reflects the bearish tone of the past week's action. Chart 1 shows the two biggest losers since March 1 being the Nasdaq Composite Index (-6.4%) and the Russell 2000 Small Cap Index (5.5%). [They were the biggest losers again this week]. Nasdaq losses have been led by biotech and social media stocks. Nasdaq underperformance is usually negative for the rest of the market. The same with is true with small caps. Small caps are perceived to be riskier than large caps and usually fall faster at market tops. That also explains why the Dow Industrial spring loss has been less than -1%. The Dow is a blue chip index that includes larger stocks that pay dividends. It's usually the last to fall at a market top. The S&P 500 has also held up better than small caps and the Nasdaq (down -1.6%). But it rolled over to the downside this week along with the Dow. Sector rotations also showed the market in a more bearish mood.
Chart 1
DEFENSIVE ROTATIONS... Sector rotations also reflect a more defensive market. Chart 2 shows the "relative" performance of the best and worst sectors during April. [The lines are plotted relative to the S&P 500 which is the flat black line]. The two best performers during April have been utilities and consumer staples, which usually attract funds when investors get nervous. Both are also dividend-paying groups which do better when bond yields fall (more on that later). [Energy stocks also held up during April]. Three of the weakest April sectors have been consumer cyclicals (retailers), financials (banks), and technology. Plunging biotechs have also made healthcare one of April's weakest groups. Those rotations are consistent with a market entering a downside correction.
Chart 2
CYCLICALS AND FINANCIALS LEAD S&P 500 LOWER... Chart 3 shows the S&P 500 falling below its March low and 50-day average to turn its short-term trend down. Heavy downside trading (red volume bars) add to the bearish nature of the week's price action. The S&P 500, however, is still well above its February low and its 200-day average (unlike the Nasdaq which is dangerously close to both). The S&P is being pulled lower by financials and cyclical stocks. Chart 4 shows the Financials Sector SPDR (XLF) falling even more in heavy trading. The XLY lost -4% for the week versus an S&P 500 drop of -2.6%. [A 4.9% plunge in banks was a big reason why]. That weaker performance is reflected in a falling XLY/SPX relative strength ratio (below chart). Chart 5 shows the Consumer Discretionary SPDR (XLY) already threatening its 200-day average (red line). The XLY was pulled lower by autos (-4.9%) and apparel retailers (-5.6%). Its relative strength ratio (below chart) has been falling since January and is now at the lowest level in ten months. It's not a good sign for the market when economically-sensitive sectors are showing relative weakness.
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Chart 3
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Chart 4
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Chart 5
MONEY FLOWS INTO DIVIDEND ISHARES ... My Wednesday message showed that money was rotating out of riskier growth stocks into cheaper (and safer) value stocks. That's a normal rotation when the market is under threat of a correction. Part of the appeal of value stocks is that they're usually larger stocks that pay dividends. Another way to take advantage of their relative safety is with the DJ Dividend iShares (DVY). [The DVY includes large cap U.S. stocks with a 5-year history of dividend growth]. The big advantage of dividend payers is that they hold up a lot better than the market during a correction. The DVY lost a little ground this week (-1.4%) which is less than half of the 3% loss for the S&P 500. [Since the beginning of March, the DVY is up 1.2% versus a loss of -2.3% in the S&P 500]. That stronger performance is reflected in the DVY/SPX ratio (top of Chart 6) which has been climbing over the last month. Falling bond yields also add to the appeal of dividend paying stocks. And bond yields are falling again.
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Chart 6
FALLING BOND YIELDS BOOST DIVIDEND STOCKS... Dividend stocks are getting a boost from two sources. One is a weaker stock market. The other is falling bond yields. Chart 7 compares the 10-Year T-Note Yield (green line) to a relative strength "ratio" of Dividend iShares divided by the S&P 500 (gray area). The chart shows the two lines trending in opposite directions. Rising bond yields (like last August and November) hurt the relative performance of dividend stocks (falling ratio). Falling bond yields have coincided with stronger dividend performance and a rising ratio (like last September, this January and March). There are several reasons for that. Dividend stocks compete with bonds for yield. Rising bond yields make dividend payers less attractive. Falling bond yields have the opposite effect. In addition, falling bond yields coincide with rising bond prices. Rising bond prices usually coincide with a weaker stock market. That drives money to dividend stocks. Another factor lies in the makeup of the DVY. Utilities are the biggest part of the DVY (35%). Utilities are viewed as bond proxies and usually rise along with bond prices. That explains why utilities were the only sector in the black this week. They've also been the strongest performers since the start of 2014. Two other 2014 leaders are consumer staples and energy. Both are well represented in the DVY.
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Chart 7
NASDAQ IS NEARING CRITICAL SUPPORT... As I wrote on Friday afternoon, the Nasdaq market may hold the key to stock market direction. That's because it's bearing down on two critical chart points. Chart 8 shows the Nasdaq Composite Index nearing a test of its February intra-day low at 3968. The second potential support line is its 200-day moving average (red arrow). The Nasdaq hasn't touched that long term support line since late 2012. Whether or not it is able to find support in that area may determine if the stock market correction is going to get a lot deeper.
