With this month’s newsletter, I feel that we only need to look at one chart to get a good feel for the current stock market environment.
I believe that for most of 2021 the market has been in a stealth correction. This may surprise you given that major indexes have advanced higher. But those indexes are capitalization-weighted and the largest stocks have an outsized weighting on performance.
Internal market weakness is typical for the year after a bear market ends. Historically, you see a strong advance off the bear market low, with investors bidding up stocks aggressively. That advance is strong and the second year is typically a year of digesting those gains. The difference with 2021 is that the S&P 500 has trended higher; however, most stocks within that index have not performed as well on average. The good news is that the stock market has typically continued to advance higher after its second-year blues.
In the chart below is a year-to-date chart of Invesco S&P 500® Equal Weight ETF (NYSE:RSP) (an equally weighted S&P 500 Index ETF) in the upper panel. While this market proxy index has trended higher this year, mid-caps have gone nowhere since the beginning of May. Small caps are worse, having consolidated since February. What about those indexes that are economically sensitive? Both transportation stocks and copper have been falling since early May.
So, what am I looking for going forward to signal a transition to a more healthy stock market environment?
I am looking for an improvement in market breadth. I want to see those lagging groups advance.
Notice how the 200-day moving averages below are trending higher in all the charts, moving closer to price. This average commonly acts as support for price.
It will be interesting to see how price reacts as this important moving average gets closer to price. Will this moving average supply an advancing force to push price higher? If so, this would be a very bullish signal for the broader stock market. On the other hand, if these four indexes continue to consolidate or fall, it would suggest more of the same.
