SMALL AND MIDCAP STOCKS CONTINUE TO LAG BEHIND S&P 500 INDEX -- CONSUMER STAPLES AND UTILITIES ARE DECEMBER LEADERS -- WHILE CYCLICALS AND INDUSTRIALS LAG BEHIND -- ROTATION FROM CYCLICALS TO STAPLES IS A SIGN OF CAUTION

SMALLER STOCKS STILL LAG BEHIND LARGE CAPS... A yearend stock rebound has boosted major stock indexes. Chart 1 shows the S&P 500 touching a three-week high yesterday. It still, however, remains below a falling resistance line drawn over its November/December highs, and is trying to stay above its two moving average lines. So far, however, this remains mainly a large cap rally. Chart 2 shows the S&P 400 Mid Cap Index trading below both moving average lines, and well below its November high. Chart 3 shows the Russell 2000 Small Cap Index in a similar weak condition. Since midyear, the SPX large cap index is basically unchanged. At the same time, mid caps are down -5%, and small caps an even large -7%. That's not the sign of a strong market. And that situation is unlikely to improve until smaller stocks start to act better.

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Chart 1

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Chart 2

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Chart 3

DEFENSIVE LEADERSHIP ... Sector leadership during December also reveals a more defensive market mood. The three top sectors during December are consumer staples, utilities, and healthcare. All three are defensive in nature. Chart 4 shows the Consumer Staples SPDR (XLP) hitting a new high. Its relative strength ratio (above chart) has risen all month. Chart 5 shows the Utilities SPDR (XLU) also having a strong month. Its relative strength ratio has risen as well. Investors usually rotate into those sectors when they're more cautious on the direction of the market.

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Chart 4

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Chart 5

CYCLICALS AND INDUSTRIALS LAG BEHIND ... Economically-sensitive stock groups are lagging behind. Chart 6 shows the Consumer Discretionary SPDR (XLY) struggling to clear its 50-day line. Its relative strength ratio (above chart) has been falling all month. Chart 7 shows the Industrials SPDR (XLI) in a similar situation. The fact that those sectors have underpeformed the market during December also suggests a lack of confidence in the market's staying power.

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Chart 6

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Chart 7

STAPLES OUTPERFORM CYCLICALS... The two lines in Chart 8 compare the Consumer Discretionary SPDR (XLY) to Consumer Staples (XLP). The XLY has outperformed the XLP by an 11% to 8% ratio since the start of the year. That's normal when investors are more optimistic on the economy and the market. Notice that during December, however, staples moved higher (blue line), while cyclicals have moved lower (black line). That's unusual in a rising market. Chart 9 shows the performance of consumer staples during the year (blue line) "relative" to consumer cyclicals (zero line). [The blue line is essentially a ratio of the XLP divided by the XLY]. The falling blue ratio between January and November shows leadership by economically-sensitive cyclical stocks over defensive consumer staples. The rising blue line during December, however, shows a clear rotation toward defensive issues. That's not a vote of confidence in the economy or the market.

Chart 8

Chart 9

ENERGY SPDR STILL TESTING LOWS... The direction of crude oil and energy shares appears to be having an influence on market direction. While crude oil is testing its spring 2009 low near $34, oil shares are undergoing a test of their own. Chart 10 shows the Energy SPDR (XLE) rebounding slightly off its August/December lows. The chart shows the its trend is clearly lower. But some hope for a rebound (or at least a period of stabilization) remains as long as those supports hold. Energy remains the weakest sector of the market (along with commodity-related material shares). The direction of the XLE from its current level may also have an impact on overall market direction.

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Chart 10

HAPPY NEW YEAR... The good news is that the stock market is getting its usual yearend bounce which leaves it basically unchanged for the year and looking a lot better than it did during August. The bad news is that the rally so far is being driven by large cap stocks. As a result, "market breadth" figures are lagging behind. At the same time, the December rally is being driven mainly by defensive groups which is a sign of caution. But those are problems for next year. 2015 appears to be ending the year on a upnote. Let's be thankful for that. We'll start dealing with 2016 next week when things start getting back to normal. In the meantime, have a safe and happy New Year.