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Mega Caps Carry the Market

An Interesting Move on Friday

Friday was a very interesting day for the markets. The S&P 500 finished the day up +1.07%. On the surface, that would seem pretty good. But, if you look at how the components of the market performed, things become a bit murkier.

The 1.07% move is misleading because of the performance of three mega cap “Magnificent 7” stocks. On Friday, after reporting earnings, META’s stock was up more than +20% and Amazon was up +7%. Nvidia was up nearly +5%.

Remember, the S&P 500 is capitalization-weighted index, meaning larger securities, like the ones that make up the Magnificent 7, have a greater impact on the index’s movements. While the index was up +1%, the equal weight S&P 500 was actually down -0.09% (meaning that the average stock was down for the day). The table below, provided by us, shows how the average stock from each S&P 500 sector performed on Friday.

Source: Canterbury Investment Management. Stock data pulled from Optuma Technical Analysis Software. Sector category pulled using S&P 500 ETFs.

Only three S&P 500 sectors had stocks that were up on average at Friday’s close. As a matter of fact, more than half of the S&P 500’s stocks were down on Friday. Most of the market’s trading volume (conviction) was actually to the downside. In other words, in order for the market to be up +1.07% on Friday, a very few large stocks had to do some heavy lifting.

A Broader Picture of the Market

The S&P 500 has low volatility right now. So far this year, there has only been one “outlier day” (a trading day beyond +/-1.50%). Generally speaking, low volatility is a bull market characteristic.

That does not mean that the markets are without issues. Only two sectors are beating the S&P 500 in the early days of 2024. The Information Technology and Communications sectors continue their outperformance from 2023. These two sectors combine for nearly 40% of the S&P 500’s market capitalization. While the S&P 500 is making new highs, the average stock is still -10% off its 1-year high. The Russell 2000 index, which measures smaller capitalized companies, is 20% off its 2021 peak.

Chart of the week- Russell 2000

That brings us to our chart of the week- the Russell 2000. The Russell 2000 measures smaller capitalized companies. Traditionally speaking, small cap stocks have been viewed as “high risk, high reward.” Lately, they have leaned towards the “high risk” side of the equation.

A chart of a Russell 2000 ETF and is accompanied by some technical notes.

Source: Canterbury Investment Management. Chart created using Optuma Technical Analysis Software. ETF shown is IWM, the iShares Russell 2000 ETF

1.     You can see that there is a horizontal “resistance” line drawn across the Russell 2000’s peaks. These are the points where supply and demand shift. Each peak has occurred around the same price level. At these peaks, supply has tended to take over and cause a “selloff.” Recently, the index briefly broke above this resistance line, but then failed when it attempted to test it for “support.” It then rallied back to it and bounced down off of it. This is a major resistance level.

2.     Directly below the Russell 2000 price chart is its MoneyFlow Index. MoneyFlow is a volume-based indicator, and often referred to as a “smart money index.” At the Russell 2000’s most recent peak, you can see that the MoneyFlow index put in a lower high than the previous peak, even though the index’s price was actually slightly higher. This is called a “negative divergence” and means that the most recent rally occurred on lower volume, indicating lower conviction in the move.

3.     The bottom portion of the chart shows the index’s relative strength to the S&P 500. A descending trend in relative strength indicates that the Russell 2000 is underperforming or has been weaker than the S&P 500 index.

Bottom Line   

The large market indexes, like the S&P 500, have low volatility. This is a bull market characteristic but is mostly due to the index’s large exposure to the best performing asset class: technology. The recent market movement has been less apparent of a rising tide lifting all ships. In other words, the bigger boats rise while smaller ones are just treading water.

Nonetheless, there are stocks and securities that are doing well. From a portfolio management perspective, our Canterbury Portfolio Thermostat has several stock positions, diversified across sectors. We also hold sector ETFs in both Information Technology and Communications.

Looking at risk management, bonds have not done well recently. If interest rates fall, bond prices will be expected to rise. Some experts are saying that inflation is not done rising, so falling rates are not necessarily a done deal. That being said, a portfolio of securities needs risk management. Currently, while our portfolio has several stock and equity positions, we also hold a few inverse securities, which move in the opposite direction of their underlying index and are held to provide some risk management.

Two of those positions are inverse Russell 2000 and inverse Emerging Markets. The Russell 2000 has a few technical characteristics going against it, which were highlighted in this update. Emerging markets is largely exposed to China, which has been one of the worst performing geographic regions. These positions help limit portfolio volatility, while the portfolio still has equity exposure.


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