By D.R. Barton of Van Tharp Institute
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Back on February 2nd we looked at the broad market indexes and saw that during a short advance over the first few days February the more speculative Russell 2000 and more notably the Nasdaq 100 were lagging the large caps.
That led to the conclusion that we would get another down leg—we did, though it was a short-lived panic low just a few days later.
Fast forward from early February to today—the opposite is happening. Since the low closes of the indexes on February 8, the Nasdaq 100 and, more spectacularly, the Russell 2000 have outperformed their large cap brethren. We can see this clearly in the performance chart from Stockcharts.com. This chart compares the percentage price movements of the different indices.
This rally shows true optimism—buyers are opting for the higher returns of the more speculative indexes despite the possibility of higher risks there. Also, some combination of the major indexes has closed up for 9 straight days. The S&P 500 has been up 8 of the last 9 days. There was only a miniscule down day on Monday, March 8; however, both the Nasdaq 100 and the Russell 2000 were up. Historically, this type of persistence has been the harbinger of a rally extending, not topping out.
In the short term, however, the market is getting overbought by many measures including some standard momentum oscillators like stochastics. Some indicators are not showing overbought like RSI, which is still in high neutral territory.
Some sort of near-term correction is fairly inevitable. The depth of the rebalancing pullback will likely foretell the intermediate direction of the market. Let’s look at a chart for key levels.
The 1086 zone in the S&P 500 cash index represents a swing low and a 0.618 Fibonacci retracement from the 2/5 low to the 3/9 high. A break below that would certainly signal a high probability for a test of the February 5th lows and beyond. The more likely scenario, though, is that we get a smaller rebalancing pullback that does not even test the 1086 zone. Were this to happen, it would signal continued intermediate strength that could last through tax season.
The bottom line for the market is that we’re certainly due for at least a moderate pullback to relieve the short-term overbought conditions. The nature of the upcoming pullback will help us gauge the strength of the current intermediate-term move. If the pullback is relatively weak, we will most likely see the markets heading even higher.
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