I Took a Close Look at the Market in the 1990s. This Is What I Found

I could easily write about the indicators and declare yet again the S&P 500 and Nasdaq indexes were up on Friday, but the rest of the market did very little because breadth was flat.

But you know that. You know that there are divergences. You know that sentiment, while no longer giddy, is back to complacent.

Lately, however, there has been so much talk about how the Top 5 market cap stocks account for nearly 20% of the S&P and that at the peak in 2000, it was only 16%, so this is even greater than 20 years ago. I decided to take a closer look at that late 1990s. I discovered something interesting.

We know that when so few mega cap stocks account for such a large portion of the moves in the index the small caps are clearly going to under perform. When we look at the Russell 2000 relative to the S&P since the summer of 2018, it has been a one way street in favor of large caps. That's the black arrow on this very long-term chart of the ratio (red) with the Russell (blue).

But what struck me when I looked at this 30-year chart is that from 1994 until the peak in 1999, it was also a one way street (green arrow) in terms of small cap under performance. And look at the breakout from that rounding bottom of the ratio in 1998 (orange line).

The ratio is currently at two, which is the same place it peaked in 2007. It has been forming the same rounding bottom pattern for about 15 years now, since around 2004-2005. I realize this is simply based on one prior observation, but perhaps the massive outperformance is going to continue, and perhaps become more pronounced.

What is interesting, though, is that from April 1998 until October 1998, the Russell 2000 lost nearly 35% -- not relatively, but absolutely. That's essentially where the green arrow points to. I had never realized that -- or had forgotten it, at least. But from that low in the Russell in 1998 until the peak almost 18 months later, the Russell nearly doubled. Yet look at how the S&P outperformed in that time frame. (You see the huge rise up and out of that rounding bottom designated by the orange line?)

I thought of all of this as I was working through some volume indicators. For years I have looked at the New York Stock Exchange's volume relative to Nasdaq's volume, using a 10- and 20-day moving average. I did this with the thought that there might be some pattern to discern. There was never anything terribly definitive. But this past weekend I decided to try a 30-day moving average, and, lo and behold, we have something of interest.

Let me take a minute to explain why I think this particular metric tells us something. My thinking is that when the volume on the NYSE is so much greater than the volume on the Nasdaq, it means folks are relatively concerned about the market, opting for the safety of "secure" big cap stocks. Conversely, when the volume of the NYSE relative to Nasdaq falls to quite low levels, it means folks are feeling far more speculative as they spread out and expand beyond the safety trade.

Take a look at the chart of relative volumes (30-DMA) over 2008-2011. See that peak in early 2009, where the moving average of the ratio got so high in favor of safety? That was the low in the market (I'm using the Russell 2000 in the lower panel). Even as you go through the ensuing years on this chart, you see that it was down to 19 in April of 2010 just before the Flash Crash -- too much stepping out of the safety zone. Late 2010 took it up to 24, meaning, relative safety. So, you can see that the spring of 2011 took it back down under 20 and we ended up with the 2011 decline.

Now let's look at today's chart. A few things jump out at me. Look at the 2016 low in markets: The peak in the indicator was quite high. Then look at the extreme low in the indicator as we headed into that October 2018 high in markets.

What I found quite curious is that the December 2018 low in the market did not see much of a surge in the indicator as it barely got over 17. Yet now we find that in mid-January the indicator has come back down and turned up.

I can easily make up a bunch of reasons that markets have changed over the years. I can easily tell you that based on that first chart of the S&P relative to the Russell there could still be an extended period of outperformance of large vs. small to come. But mostly I think these charts tell us the market has already started to get narrower and more concentrated and that is unlikely to change in dramatic fashion. The question is when will the market and market participants start caring about it.