Trader’s Narrative

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While this bear is busy mauling everything in its path, there are some pockets of strength. One of them is right under our very noses: the Nasdaq composite index.

The individual charts of the Nasdaq composite and the S&P 500 Index, each show a crushing bear market. But the relative chart shows that out of the two, the Nasdaq is surprisingly strong.

Going as far back as 2006, Nasdaq’s relative strength has been putting in higher highs and higher lows.

But before we can get excited, the ratio of the Nasdaq to the S&P 500 ratio has to break 1.90 - that’s because since 2004, it has been in a holding pattern below that level. The last time it broke through was in early 1999, and you know the rest of that story.

Financial Sector
Of course, the sector that has everyone’s attention is the financials: banking, investment houses and brokerages. Although technically, a bull market doesn’t need the financial stocks leadership, this market has been primarily driven by the bank stocks because they have been the protagonists in this tragedy (or farce, depending on your point of view).

Today, the financials make up only about 10% of the S&P 500 index. So in a twisted sense, this sector has fallen so much that from here on in, it has much less weight to influence the general index. And that might be a good thing because while it may take decades for the US banks to come out from under the shadow of government intervention into some semblance of normalcy, the rest of the market can push forward.

Looking at the percentage of stocks above their 50 day moving average is a quick and dirty way to find out where the market stands in the medium to short term. Looking at the percentage above 200 day moving average provides a much broader perspective.

Line In The Sand
The 200 day moving average is like the proverbial “line in the sand”. If a stock can’t hold above it, technically speaking, things are really rotten. But while that may be negative for one individual stock, when as a whole the market crosses that threshold, it usually is a sign that things have reached an extreme and are about to return to normal.

Right now, the percentage of stocks above their long term moving average are at levels which in the past have seen a resumption of the bull market. The index that got the most oversold was the Nasdaq Composite (COMPQ) which reached 34%. The next one was the S&P 500 (SPX) which got as low as 43%.

Large Cap vs. Small Cap
But there is an obvious dichotomy. Whereas the broad indices (containing a mix of small caps and large caps) show an extreme low reading for this indicator, the large caps are almost unscathed. The Nasdaq 100 (NDX) index, for example, has 60% of stocks above their 200 day moving average while the S&P 100 (OEX) has 62%.

This is no surprise since we all know that the small caps have gotten crushed in this correction. A cursory look at the Russell 2000 (RUT) shows it correcting about 12% (from recent high to recent low) - almost double that of the large caps.

Unless for some reason you believe that we are heading into a new bear market, this is as bad as it is going to get. I reiterate that this is a buying opportunity if you have a medium to longish time horizon. Especially the financial sector.

Here’s the chart for the NYSE and the S&P 500. Notice the difference between a bear market bottom and bull market inflection points: