For weeks now we've been paying close attention to the Russell 2000 thanks to its underperformance throughout the spring and July. Two weeks ago, the index began outperforming for the first time in two months -- only to take the back seat once again this past week. This week, though, I want to take my eyes off the small-caps and concentrate on the Nasdaq.
One reason for this is that the Nasdaq has essentially been the leader since the high in July. It did not fall nearly as much that month as the other indices did, and it has become the go-to index since it became oversold just over a week ago -- it has outperformed to the point at which it is now a mere 20 points, or less than 0.5%, from its July high.
To contrast with that, the S&P 500 is still about 1.5% from its July high. The Russell is still more than 5% from its July peak.
With the Nasdaq oh so close to a higher high, and with the market heading toward a moderate overbought condition, I think it's time to consider that we could easily see a negative divergence on a new high. For example, on Friday the Nasdaq saw 66 stocks making new highs. In early July there were just over 200. So this number would have to more than triple in order for the metric to confirm a higher high in the index. It's possible, but is it likely?
While I have been praising breadth for the past two weeks, I have been focusing on the breadth of the NYSE. As I have noted several times now, the Nasdaq's breadth has lagged -- and it continues to do so. If we use cumulative volume as our example, at this point the Nasdaq would have to have net volume -- up minus down volume -- of approximately 2.6 billion shares in order to confirm a higher high. (Using the advance-decline line produces even worse results.)
The Nasdaq's recent run off the lows comes to approximately 100 points. That run produced a 2.25-billion-share gain in volume. Ask yourself if you think a 20-plus-point rise in this index can produce a gain of 2.6 billion shares in cumulative volume. I think not.
Keep this in mind: It has been my view that the market has needed to rally and come back down -- or that we've needed to see capitulation. I don't think we've seen the latter, so the market is currently enjoying an oversold rally that should lead to a decline. At this point I believe it's working on a "W"-shaped formation -- and that it's on the first leg up, in the middle of the pattern.
The way the indicators line up, most of them are trying to turn upward and some have already done so, as I have noted here all last week. A decline in the latter part of August would set up the indicators such that the market could enjoy a better rally in September, having completed a "W" formation. Continued chopping to the upside won't help the market at this point. A pullback later in the week will.
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