Friday, May 05, 2006

What's Really Happened While the Dow Made New Highs

As the Dow has made new highs, the broad market has been weaker. On Thursday, for example:

We had 41 new 52-week highs in the S&P 500 Index, down from 80 two weeks ago.

We had 61 new 52-week highs in the S&P 600 Index of small cap stocks, down from 100 two weeks ago.

We had 36 new 52-week highs in the S&P 400 Index of mid cap stocks, down from 62 two weeks ago.

We had 1 new 52-week high in the Dow 30 Industrials, down from 5 two weeks ago.

As the Dow made new highs on Thursday, momentum among stocks in the major averages was down, as well:

We had 62% of S&P 500 stocks above their 20-day exponential moving average, down from 80% two weeks ago.

We had 63% of S&P 600 small cap stocks above their 20-day EMA, down from 78% two weeks ago.

We had 56% of S&P 400 mid cap stocks above their 20-day EMA, down from 70% two weeks ago.

We had 70% of Dow 30 Industrial stocks above their 20-day EMA, down from 90% two weeks ago.

Growth stocks have underperformed value stocks during the recent Dow strength:

Since April 19th, value stocks within the S&P 500 have outperformed growth stocks.

Since April 19th, value stocks within the Russell 2000 small cap stocks have outperformed growth stocks.

As the Dow has made new highs, sectors have moved in different directions:

Real estate stocks (IYR) are down more than 5% since March.
Retail stocks (RTH) are down about 3% since March.
Semiconductor stocks (SOX) are down about 4% since March.
Housing stocks (HGX) are down over 8% since March.
Defense stocks (DFX) are up about 5% since March.
Oil stocks (XOI) are up nearly 10% since March.
Gold and silver stocks (XAU) are up over 20% since March.

In short, we've been seeing sector rotation out of growth and into value hard assets as interest rates have risen, energy prices have climbed, and the dollar has declined. The market seems to be betting against the consumer and against a robust economy.


RexCoroc said...

Great posts. I'm a neophyte trader still trying to find my way. Your comment:

"The market seems to be betting against the consumer and against a robust economy"

The market betting against the consumer I agree with however the performance of the transports, the price of copper.... all point to a market betting on a robust economy,to me.

I also, believe the market is not on solid ground, however that does not mean it corrects any time soon. I get into trouble as a trader when I develop to strong a macro directional bias.

Brett Steenbarger, Ph.D. said...

Thanks for your note. Too strong a bias can indeed be a problem. Understanding market themes and the flows of capital can be very important. Money has been flowing toward hard assets, away from interest rate sensitive sectors, toward value, away from growth. That has been occurring over the last year, and it's been occurring over this past week. No sign from my end that the themes are changing.


Jackass said...

why would stocks be rallying on anticipation of the Fed ending interest rate hikes while the bond market is not? it seems like if the market was convinced the Fed was about to stop raising rates the curve would be steepening and it is not. in fact it really has barely budged (4bps not material). who do you trust to better interpret Fed policy? bond traders or stock traders.
interesting today the leading sector in the S&P is utilites which is defensive (and interest rate sensitive i realize) and lagging sector is tech. the NDX hasnt' even taken out the morning's opening high despite the Dow making new highs..
i always attribute the "one and done" rallies to be multiple expansion bets where traders look to beta but today that is not the case. very stange price action.
good looking blog. i'll be back

Brett Steenbarger, Ph.D. said...


You're asking a great question. The fixed income markets are anticipating higher rates, responding more to inflation concerns than to the theme of the Fed ending its hikes. Equities, meanwhile, are rallying, but selectively. Of the large cap stocks in my basket, only a handful are making new 52-week highs today despite new highs in the large cap indices. I interpret all of this as late bull market cycle behavior, in which large caps start to outperform more speculative, growth issues. If you recall, the Dow made its cyclical highs in May, 2001, well after the more speculative NASDAQ had peaked in March, 2000. It is only when a falling dollar (rising commodities)takes its toll on bonds, which in turn dampen economic activity and the outlook for equities that bear cycles take over. John Murphy's work on intermarket relationships documents this well. IMHO, the current economic cycle looks more like ones he has documented than the unusual 2000-2003 experience.


Jackass said...

do you have a link or reference to Murphy's work?
i concur and having worked in all three major markets, commodites, bonds and then stocks conclude that they are all joined at some level. you can't have a free lunch and markets will adjust. most pundits when they refer to low interest rates look at nominal 10YR yields but i watch the 2s/10s spread. when the Fed took rates to 1% the 10YR note was low but the 2s/10s spread was as wide as it gets (250bps) and was restrictive despite the low nominal rate. the real damage to stocks throughout '01-'03 was done in unison with a widening of the yield curve and the rally out of '03 corresponded with a flattening yield curve which was stimulitive. now the Fed appears to be looking at an end of tightening but the dollar/commodites are telling you that they have more work to do. if they stop prematurely the bond market will take over and start to tighten thru a wider curve. this will be the catalyst that turns the cycle in my opinon.
also, i see where NYSE margin debt is at the same level as 12/99 and not far off the high in 3/00. coincidence? the recent low in margin debt was 9/02 a month before the low in price.. i guess as the market gets extended and cash is tight, traders tap more margin at the tail end of the advance. do you have any work on the margin debt relationship? thanks and i'll shut up...

Brett Steenbarger, Ph.D. said...


Thanks for the great comments re: margin debt. That is an area I'd like to explore.

John Murphy's book is called "Intermarket Analysis", and it's put out by Wiley. It's available via Amazon. Many of the cycles he reviews end precisely because of the dynamics you mention: weak dollar, weak bonds, then falling stocks.


Casey said...

I enjoy the way you analyze and investigate the underlying market Dr., especially with respect to the highs, lows and # of stocks above/below certain day averages. It makes sense.
Regarding intermarket relationships, Murphy mentions that a falling Bond/Stock ratio is associated with economic strength. That trend is still ongoing. Would it be fair to say that one should stay bullish ( in an intermediate position ) until that trend is broken?

Brett Steenbarger, Ph.D. said...

Thanks for this excellent observation. My understanding from Murphy's work, as well as other intermarket research, is that interest rates tend to bottom (bonds tend to peak) prior to cyclical peaks in equity markets. The lag between these peaks, however, is quite variable, so this is not a precise timing tool to be sure. If a bond/stock ratio is falling because bonds are distinctly weak, that would mean something different than if the ratio is falling because of rising stocks.

In my Trader Performance blog on my personal site ( tomorrow, I will post more on this topic.


oxbird said...

Excellent blog and comments!

My concern is with the general increase of prices of all asset increase in the nominal price of index shares and in the prices of commodities, such as metals and energy. I also observe the dramatic decline of the U.S. Dollar vs. other currencies.

I wonder if you are aware of a similar set of circumstances at some point in history.....where stocks might have become a hedge against inflation and where other factors (including manipulation of the markets) may have caused an extended period of increasing nominal share prices....???

Brett Steenbarger, Ph.D. said...

It's a excellent question; thanks. I'm not exactly an expert on financial history, but my understanding is that periods of high inflation (i.e., declines in the value of the dollar vis a vis the goods and services utilized by consumers and producers) over time correspond to declines in the value of all financial assets (bonds, stocks) relative to hard assets. As I wrote recently in Trading Markets, the S&P 500 Index, priced in ounces of gold, has barely rallied since 2003. I suspect the Dow's recent rise, demoninated in Euros or Yen, also would look a lot less robust. The high inflation periods of the 1970s and early 80s were particularly unkind to equity values, especially if you priced stocks (such as the Dow) in constant dollars. All of those considerations lead me to question stocks as long-term inflation hedges during periods of high inflation. The 60,000 dollar question now IMHO is whether the tremendous rise in commodity prices is foretelling such a rise in inflation at the consumer and producer levels.