STOCKS HAVE STRONGEST OCTOBER IN FOUR YEARS -- S&P 500 ENDS NEAR TWO-MONTH HIGH BUT LOOKS OVER-EXTENDED -- EQUAL WEIGHT STOCK ETFS NEED TO CATCH UP -- JANUARY EFFECT SHOULD BOOST SMALL CAPS -- WEEKLY MACD LINES TURN POSITIVE
HALLOWEEN INDICATOR ... Stocks had the best October since 2011. That bodes well for the rest of the fourth quarter and the next six months. The three months between November and January are traditionally the best three months of the year. As is the six-month period between November and April. As happened during 2011, stocks peaked in May and bottomed in October. The rally starting in October is part of the "Halloween Indicator" that I described in a previous message. It's the second part of the "sell in May" maxim, which is to buy stocks back around Halloween. One of the concerns about the market rally is lack of participation by small and midsize stocks. That situation should improve as the January Effect starts to kick in. The "January Effect" refers to the tendency for small caps to do better than large caps heading toward January. According to the Stock Traders Almanac, small cap strength usually starts to pick up in late October. That should also serve to broaden out the stock market rally. Chart 1 shows the S&P 500 ending the week just shy of a two-month high. Some end of month profit-taking may have contributed to Friday selling. But the trend is clearly up. The 14-day RSI line (top of chart) shows a short-term overbought condition near 70. On any pullback, initial chart support resides near 2060 which coincides with the 200-day moving average. More significant chart support is at the 2020 level which coincides with the September peak.
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Chart 1
EQUAL WEIGHT ETFS LAG BEHIND... The S&P 500 Index shown in Chart 1 is a market cap index. That means it gives greater weight to bigger stocks. Chart 2 shows the S&P 500 Equal Weight ETF (RSP). As its name implies, the RSP gives equal weight to each of its 500-day stocks. That means that smaller stocks are given the same weight as larger stocks. That's why the RSP is lagging behind the SPX, and it has yet to clear its 200-day line. A move above its 200-day line would help alleviate concerns about lagging "market breadth". By contrast, Chart 3 shows the Nasdaq 100 Equal Weighted Index (QQEW) already trading above its 200-day line. It's not rising as fast as fast as the Nasdaq 100 which has reached its summer high (top of chart), but both are in uptrends.
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Chart 2
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Chart 3
WEEKLY MACD LINES TURN POSITIVE... My October 19 message showed weekly MACD lines for the S&P 500 bouncing off previous support at its 2011 low. It also showed the two lines starting to converge, which signalled improvement. I pointed out, however, that the two weekly lines needed to turn positive to confirm that an important bottom was in place. Chart 4 shows the weekly MACD lines turning positive for two weeks in a row. That positive crossing is confirmed by the green histogram bars moving back above their zero line by the widest margin this year. For the record, the weekly MACD lines also turned positive during October 2011. [Although monthly MACD lines are still negative, they too are starting to converge for the better].
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Chart 4
CYCLICALS HIT NEW HIGH, WHILE STAPLES SLIP ... It seems strange to see upside leadership in cyclical stocks and staples at the same time. Cyclicals are economically-sensitive, while staples are defensive. This week, however, their paths started to diverge. Chart 5 shows the Consumer Discretionary SPDR (XLY) ending the week at a new high (with a rising relative strength line), while Chart 6 shows the Consumer Staples SPDR (XLP) ending lower (with a falling relative strength line). The reason for their different path may be this week's bounce in bond yields. There may be some good news in that.
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Chart 5
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Chart 6
RISING RATES FAVOR CYCLICALS ... To get a better read on the state of the market, it's better to compare the two consumer sectors directly. The black line in Chart 7 is a "ratio" of the Consumer Discretionary SPDR (XLY) divided by the Staples SPDR (XLP). The green line plots the 10-Year Treasury Yield. There's a correlation between the lines. When bond yields are falling (like in 2014 and this past summer), staples usually do better. When yields are rising (first half of 2015 and this October), discretionary stocks do better. This past week, for example, saw bond yields jump to a one month high on the Fed statement hinting at a possible December rate hike. At the same time, the XLY/XLP ratio broke out to a new high (the XLY rose while the XLP fell). Here's my theory. The Fed statement showed more confidence in the economy, which favors economically-sensitive stocks. Rising bond yields reduce the appeal of defensive stocks that pay dividends. Like consumer staples. That also explains why utilities fell sharply on the Fed statement. It's usually a good sign for the economy and the stock market when cyclical stocks are doing better than staples.
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Chart 7
NYSE BULLISH PERCENT INDEX EXCEEDS 50% ... The NYSE Bullish Percent Index (BPNYA) measures the percent of NYSE stocks in point & figure uptrends. As such, it's a good measure of "market breadth", or the percent of stocks participating in the market rally. Chart 8 shows the index rising above 50% this week for the first time since July (second circle). That means that more than half of NYSE stocks (53%) are now in uptrends. Interestingly, the index also crossed above the 50% line in October 2011 (it ended the month at 65%). This year's BPNYA reading isn't as strong as 2011, but it isn't far behind and is heading in the right direction.
