Classic Bull Trap? Last Week's Bull Run Missing Confirmation of Breakouts

Although the S&P 500, the Dow Jones Industrial and the Nasdaq experienced "break out" weeks last week, Tate Dwinnell is still cautious to call this a raging bull market as the volume remains a bit tepid. Barry Ritholtz also misses confirming volume.

Eddy Elfenbein noticed that stock prices still lag behind earnings growth. Therefore, he can´t think of a real bull market as price/earnings ratios decline. And J.D. Steinhilber highlights the fact that the S&P 500’s earnings yield is higher than the 10-year Treasury yield.

A deeper look into the market reveals that the recent break out of the S&P 500 could be a bull trap and the S&P 500 could soon resume its downtrend.

Barry Ritzhold recently highlighted the current rotation from small cap into large cap stocks which can be identified by the relative performance of the S&P 500 Index against the S&P 600 Small Cap Index. The recent up move in the chart below suggests that this rotation is underway since the market topped in May.

A look at the chart of the S&P 600 Small Cap Index and the S&P 400 Mid Cap Index reveals that both small caps and mid caps are still in their downtrend.

Given the fact that the S&P 100 is just 0.75 percent below its 52 week high, the recent breakouts of the major large cap indexes seem to be a result of the rotation from small to large cap stocks and not a true trend reversal.

The action in the volume also confirms this interpretation, as the the volume in the large cap indices in the last days was clearly higher than the volume in the small and mid cap indexes. The lack of confirming volume was much more visible in the small and mid cap indexes than it was in the large cap indexes.

However, if the recent up move in S&P 500 Index is a real trend reversal, the S&P 600 Small Cap Index and the S&P 400 Mid Cap Index should also break out of their downtrends.

Comments

[SA Editor J...:]

Oliver,

When do you expect we'll start to see the small and mid caps "break out" if this indeed the start of a genuine bull market?

2006 Aug 21 05:22 AM

[Oliver Schw...:]

Jonathan,

I have to tell you that I am currently still bearish for the US market.
However I think there are two important factors which should be followed closely as they currently indicate a different outcome of the latest correction.
At first, the VIX has broken its support zone between 13-14 on the downside, which can be intertreted as a positive sign for a possible bull market.

As Gray Dorsch pointed out in his latest Global Money Trends Newsletter, another important factor is the Reuters/Jefferies CRB Index which broke below its 200 day moving average on Thursday. I would interpret this as a negative sign for a possible bull market.

I think a strong rise in commodities, while the VIX stayes at these low levels, could help the small and mid caps to break out.

2006 Aug 21 07:13 AM