Market Participation A Possible Red Flag

August 26, 2015

Despite the recent correction, this summer—and even most of the year so far—has seen the common gauge for the broad market, the S&P 500, move sideways.

This lack of trend seems to have market participants getting a bit antsy, wondering when they will see a breakout that sticks in either direction. It also has market commentators digging a bit deeper into what is driving the market action. Market trend and breadth are seemingly becoming a more popular topic in the mainstream.

Lack Of Movement

The S&P 500 has been stuck in a sideways trend for a majority of the year. Since the end of February through Aug. 19, the S&P 500 has returned -0.22 percent on a total return basis. There are a few interesting notes on the move:

  • The magnitude spent in positive and negative territory since February is very symmetrical. See the chart below, which is the total return line of the S&P 500, with the sum of the negative (red) and positive (green) areas notated.

  • Another example of the lack of trend is that the S&P 500 has crossed above/below its 50-day simple moving average 37 times this year. That is the highest number of crossovers in any year (and we are not even eight months in!)

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:

So while the market-cap-weighted version has rallied since the end of February, the same cannot be said for the equal-weight counterpart; meaning, the growth has been fueled primarily by the “big guys” only and not the collective group. Conversely, the smaller names in the index to which the equal-weight version has more exposure have lagged.

Here is a scatter chart of the relative weight of the constituents of QQEW compared with QQQ on the horizontal, and the performance since the end of February on the vertical (with some of the “big guys” notated). The red zones are the cause of the negative dispersion (either underweight a strong performer or overweight a weak performer).

The Takeaway

While the broad equity markets have done essentially nothing over the past six months in terms of price moves, the underlying breadth action over the same period shows signs of cracking. There is a chance this dispersion could reverse to the upside, but a lack of participation is a definite warning sign for the overall health of the market.

At the time this article was written, Stadion held long positions in QQQ. The above constitutes the personal, professional opinion of Clayton Fresk, CFA, and does not reflect the views of Stadion Money Management LLC. References to specific securities or market indexes are not intended as specific investment advice. Founded in 1993, Stadion Money Management is a privately owned money management firm based near Athens, Georgia. Via its unique approach and suite of nontraditional strategies with a defensive bias, Stadion seeks to help investors—through advisors or retirement plans—protect and grow their “serious money.” Contact Stadion at 800-222-7636 or

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