Divergence is Gentle on My Mind

Divergence is Gentle on My Mind

Navigator Algorithm Models = 100% Cash

This morning I will discuss the continuing divergence – or under performance – of the NASDAQ 100 relative to the S&P 500, Dow Industrial, and Russell 2000 indices. Divergences tend to lead peaks in the indices – but not always. I examine the current situation and potential for a melt-up, highlighting that the divergence may be tolerable in light of healthy sector rotation. More rotation follows this morning on another positive vaccine announcement from Moderna. But is all of this what the market has already anticipated, making a peak more likely? I assess this problem as well, as we approach the top line of the megaphone channel again.

Let’s begin with a trip down memory lane. When you can’t even get a price, the market is in trouble. On this day in 1999, the NASDAQ’s total trading volume pushed toward a record of 1.5 billion shares. The NASDAQ’s trading systems melted down under strain, and electronic quotes and trade reports were unavailable for 17 minutes in the late afternoon.

Was the market in a miserable correction? No. The market and the NASDAQ 100 were melting up into the tech bubble that peaked the following year. I don’t need to remind many of you what happened next. We did not find the first bottom of that fiasco until October 2002. And we tested that bottom again all the way out in March 2009, which is where our current bull likely began.

That is seven years of attempted progress only to boomerang to the same starting point. Depending on your circumstances and timing, that can put quite a negative spin on your “buy and hold” plan, especially if you retired in 2009. For a trader, however, it was all a dream come true.

Current parallels to 1999 are a bit unsettling. We saw the 1999 NASDAQ 100 index melt-up into the Internet stock bubble.  Perhaps the Internet stocks are close cousins to the rip-roaring, stay-at-home technology stocks of our time. 1999 saw record IPOs as now. Lest I forget, 1999 saw a soon to be contested Presidential election on the horizon. Haunting, isn’t it?

Back to the future, Moderna announced a nearly 95% effective rate for its new China Virus Vaccine this morning. Rumors of the announcement had already floated over the weekend. Not surprisingly then, the equity futures markets opened strong in the first 30 minutes of trading last night and remain near that level now. Using the S&P 500 futures as our market proxy, the index conquered 3600 again, just as it did a week ago on the Pfizer announcement. Vaccines before the end of the year are nothing short of extraordinary accomplishments in these extraordinary times.

For the markets, however, there is always a caveat. As the old Wall Street saying goes – “buy the rumor and sell the news.” The genesis of the axiom is this – the stock market is a leading indicator. It anticipates the future. But what happens when that future arrives? Has that future arrived? Should we bail here?

The fabulous rally that has ensued since March was fueled by a realignment of paradigms favoring stay-at-home technologies. This accelerated uptrends in stocks already poised to benefit. The earnings that followed have not disappointed. No doubt there was a dose of vaccine optimism, and a few false rotation starts, but nothing solid. In a sense, then, the future has somewhat arrived but not completely.

Investors all along maintained a healthy skepticism about vaccines and their timing. In light of this, investors left many real economy stocks behind. The latter group is now getting its day in the sun on the vaccine news. Rotation of profits from tech into real economy sectors, alone, is no reason to bail. In fact, this is exactly how a new bull market should unfold.

Personally, I am still conflicted as to whether this is a new bull market or a continuation of the old one. It likely does not matter. Broadening the rally’s wings as the climb unfolds keeps the patient healthy.

We will follow the algorithms, but it makes sense to let the catch-up rally manifest before running for the hills. We could even be entering a melt-up phase in the current market such as we experienced in 1999. If this were 1999, there was still gas in the tank before the 2000 peak. Just remember that the Internet Bubble did peak finally, as all bubbles do.

I have mentioned my personal focus on financial and energy stocks, but index investors also are spreading their wings into the Russell 2000 Small Cap Index (IWM is the ETF symbol), now on the verge of new, all-time highs. Investors also seem to be favoring the real-economy orientation of the Dow Jones Industrial Index (DIA is the ETF symbol). The Dow index just recently achieved all-time highs and is approaching 30,000 this morning, surely another milestone.

That brings me back to the divergence that is “gentle” on my mind. The NASDAQ 100 has continued to under perform the other major indices this morning and in Globex, just like last week. I think of the NASDAQ 100 as the generals and the stocks catching up as the soldiers. We often discussed that the market could not continue to live on a handful of tech stocks alone, just as you cannot fight a war with the generals alone. The soldiers must follow, and now they are.

So I am making some allowance for the NASDAQ 100 underperformance. Healthy profit-taking in these names is understandable, as long as the money rotates into the soldiers and does not leave the battlefield.

Regardless, I never sleep in the proverbial sense. I always have one eye open.

The NASDAQ 100 divergence requires our continued consideration, as do reasonable upside profit targets.

We are once again approaching the top channel line of the megaphone pattern. The line remains just under 3700 on the S&P 500 futures contract. We tagged 3668 as the all-time high on the S&P 500 futures a week ago today. Frankly, I am still straining to find another, higher target unless we are truly in a melt-up. I will continue to work at it.

What I could see happening is a looping crawl up and along the S&P 500 Index megaphone top channel line for a time. There have been other, rather long periods where the index hugs the upper channel line. Many of those periods also reflected a dose of rotation. Anyway, that is an optimistic view.

The alternative is a larger correction or continuation of the recent trading range. There is also the thought of some longer-term cycle, such as the 80-year cycle, coming down over the top of us, as we discussed last week. The possibility is no more pleasant than the roof caving in at your home. Consequently, we need to stay vigilant.

Truly, there is no rest for the weary in this undertaking of trading and investing. Yet, the endeavor remains an all-encompassing and alluring puzzle. It keeps me busy and my mind off the other craziness in the news.

For today, enjoy the market’s respite from the other problems in the spectrum. We will leave the bubble and cycle worries for another day.

Be careful.

AF Thornton

Website: https://tradingarchimedes.com

A.F. "Arthur" Thornton is an expert in logic, risk/reward quantification, market fractals, pattern recognition and asset class behavioral analysis with 34 years devoted to developing algorithmic and quantitative trading systems. In addition to trading his own capital, Mr. Thornton designs custom algorithmic and quantitative trading systems for a small and exclusive group of exceptionally qualified traders.

Subscribe!

Free Blog content and videos delivered to your email.

Health and Wealth Podcast Coming Soon!

We value your privacy, never sell your information, and detest spam!