Weekly Update

Behind the Headlines, The Stock Market Is Weakening

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Published July 16, 2021

The stock market is in the midst of a correction, a pullback in price. With broad market indexes hitting new highs, this assertion sounds clearly wrong. However, look under the surface of those indexes and most stocks are going nowhere, with a sizeable chunk of them declining. The first chart shows how the equal-weight S&P 500 index has been underperforming the index for the past six weeks, and markedly so.

Equal-weight S&P 500 index

Same conclusion in the second chart, this time looking at the Nasdaq. The equal-weighted version has made no price progress the past three weeks while the QQQ, heavily weighted toward the 5 “FANGMA” stocks has pushed upward.

Equal-weight Nasdaq index

Looking at the components of the Dow Theory – the Dow Jones Industrial Average (DJIA, red line) and Transportation Index (dotted blue line) – we see the same behavior. The transports slumping for eight weeks while the price-weighted DJIA grinds higher.

Dow Theory – the Dow Jones Industrial Average and Transportation Index

This is what a correction in a strong stock market looks like. Instead of outright selling of stocks, investors are merely shifting their bets to less risky places. For the past few years, the less risky place has been the FANGMA stocks, which have dominated the stock market.

International stocks have exhibited some of the same behavior – moving sideways in a “correction through time” while investors await evidence that the pandemic is fully over and stronger global economic growth in the offing. This chart shows emerging markets (purple), Europe (green), Japan (blue), all trading flat for weeks or months.

International stocks

This correction, whether it ultimately takes the broad indexes lower or not, is to be expected. The chart below shows how sharply stocks have moved upward since the announcement of a successful Covid-19 vaccine back in November. The chart below shows a moderately conservative ‘balanced’ fund owning both stocks and bonds. Even that moderate fund is way outside the typical lift for a bullish period. The MACD index in the lower chart showing the fund to be at nosebleed levels (circled) after the rally.

Note: FANGMA is an acronym for a collection of the stock market’s biggest, most influential stocks – e.g. Facebook, Apple, Google, Microsoft, and Amazon. The ‘N’ is for Netflix, which is quite a bit smaller and less influential these days. This collection of stocks comprises 20-30% of the S&P 500 and Nasdaq 100, two of the largest and most watched stock market indexes.

Conservative ‘balanced’ fund

In summary, while the headline indexes grind higher, the stocks fueling the rise are becoming fewer and fewer. This might ultimately cause broad market indexes to decline. Or there might be a flat march across time, as we have seen with some international indexes, while the heavily overbought condition eases. Either scenario likely paves the way for higher prices in the future as falling unemployment is substantially correlated with higher stock prices in the long run, and the initial thrust from last November looks very much like the beginning of a new multi-year run.

Market Update

Earnings season kicked off this week with the big banks reporting. Ahead of the first batch of earnings, stocks rose +0.3% Monday. They gave all of that gain back Tuesday when a consumer inflation report came in hotter than forecast. Interest rates kicked higher while smallcap stocks suffered a heavy -2% slide. Broad market indexes held flat Wednesday with several cross-currents at work. Bank earnings came in strong, but revenue was light. Investors sold off the group on that news. Oil prices slipped as OPEC finally reached a member agreement. The UAE was granted higher production limits, which perhaps acted as a catalyst for the lower prices. Fed Chair Powell testified before Congress, continuing the central bank’s cautious tone toward economic growth while acknowledging the higher inflation, which the bankers view as transitory. Unemployment claims continued falling in a report Thursday. Yet interest rates slumped back under the closely-watched 1.30% (for a 10-year U.S. Treasury bond). Stocks edged lower by -0.3%. Retail sales came in above forecast in a report released Friday. However, the initial positive response spurred sellers into action. Stocks fell throughout the session to a -0.8% close.

Stocks slipped back on a sell-the-news feel as corporate earnings season started. For the week, the S&P 500 (SPY) dipped -0.96%. The Nasdaq 100 (QQQ) touched lower by -0.96%; its first losing week since early May. Smallcap stocks felt more pressure with the Russell 2000 (IWM) index sliding -5.05%.

Warm wishes and until next week.