Market Participation A Possible Red Flag

August 26, 2015

While the S&P 500 has essentially flatlined since the end of February, we have seen some divergence in other broad-based indexes such as the Nasdaq and the Dow Jones industrial average:

So while the Dow Jones industrial average has been weaker (it recently experienced the “Death Cross,” where its 50-day moving average crossed under its 200-day moving average), the Nasdaq has proved to be a bit more resilient. However, that relative strength may have some weakness underneath.

Lack Of Participation

Market breadth is an important measure I look at to see if market strength is sustainable. As described above, the Nasdaq has proved resilient relative to other indexes. But how many market participants are driving that strength? The following chart shows the number of market constituents that are trading above their respective 50-day moving averages:

This is a case of a negative divergence between the price moves and underlying breadth. The number of constituents driving the index price continues to decline. This is not sustainable and can remedy itself in either of two ways—by breadth catching back up to price, or the more daunting option of price catching down to breadth.

An alternative view of this is to look at the divergence in the traditional market-cap-weighted index and the equal-weighted version. For this comparison, I’ll use the Nasdaq 100 (the top 100 names in the Nasdaq), which is the basis for the market-cap-weighted PowerShares QQQ (QQQ | A-66) and an equal-weighted version, the First Trust Nasdaq-100 Equal Weight fund (QQEW | A-69). Here is a relative performance chart of those names since the same Feb. 27 start date:

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