The Facebook-Driven Rally

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Includes: AMZN, CAT, FB, GOOG, GOOGL, NFLX, QQQ, SPY
by: Ravi Bala

Summary

What is propping up the Nasdaq?

Why is the S&P 500 constantly stalling?

Market internals are convoluted and the answer is not so simple.

Will the market crash? This is on the mind of everyone. Let us look at the sentiment courtesy of StockTwits to get an idea. Sentiment seems negative for the S&P 500* (NYSEARCA:SPY). Usually that is an indication that the shorts will get their heads ripped off, but let's keep going.

(Source: StockTwits)

Ah, this is an interesting observation. Why are people bullish on the Nasdaq* (NASDAQ:QQQ) but bearish on the S&P 500? Something does not click. What stocks are propping up the Nasdaq?

(Source:StockTwits)

Well, one of the primary culprits is Facebook (NASDAQ:FB), but we will get into more of this a bit later.

(Source: StockTwits)

With a five percent weighting, it has been one of the major stocks propping up the Nasdaq. So, here is the concern. Can the Nasdaq continue to climb higher while the S&P 500 continues to struggle along?

Below are two charts of Nasdaq and S&P 500. Usually, Nasdaq will lead then S&P 500 will follow. Don't interpret these as technical signals because they are not. In order to get back to previous levels, Nasdaq needs to move close to 300 points. However, the S&P 500 is at its previous levels. This pretty much aligns with the above sentiment of the indices, but it is an incomplete picture. Those who voiced their opinion really did not take the time to understand the correlations of both indices and how they impact one another. Now an interesting fact you might not know is that for every two points the Nasdaq moves, the S&P 500 moves one point. It's not exact, it's an approximation.

Click to enlarge

Now it begs the question - can the S&P 500 move an additional 150 points? This would take the index from its current level of approximately 2030 to 2180? This would drive the S&P to new all-time highs. My conclusion is something is going to crack.

When we dig a little deeper, we have economically sensitive stocks such as Caterpillar (NYSE:CAT) continually declining. Now if the S&P 500 is a measure of the economy and the GDP has been declining, then the index should mirror Caterpillar. Unfortunately, that is not happening. The index level is being held by rising Nasdaq stocks such as Facebook. However, if Facebook is rising, does that mean the S&P 500 is being propped up by the famous FANG stocks?

Click to enlarge

Below are the charts of the famous FANG stocks.

Click to enlarge

These four stocks make up nearly a third of the Nasdaq weighting. As you can see, only Facebook and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) seem to have some life in their stock. Netflix (NASDAQ:NFLX) and Amazon (NASDAQ:AMZN) appear to have lost their luster. Yes, correlations break down from time to time, and it appears this correlation has run its course. Out of Facebook and Google, Facebook appears to be the outperformer.

Given its weight and outperformance in the S&P 500, it appears that Facebook may indeed be one of the primary culprits of this divergent market behavior.

Thus, I can conclude that the S&P 500 is perhaps being propped up by the Nasdaq stocks with Facebook being one of the prominent ones. The rise and weights of these stocks are canceling out the effect of the decline in the economically sensitive stocks of the S&P 500 which is creating a slow grinding market. A select few stocks cannot continue to prop up the market for an extended period of time. If Facebook cracks and other stocks that have similarly risen such as Google crack as well, the fall will be nasty. Thus, it appears that the Nasdaq having room to run up 300 points is a facade as well. There is no possible way for Facebook to contribute a majority of the points necessary to boost the index by that amount. I have to reiterate that something has got to crack.

On the bright side, it will realign the indices so you will not have such a divergent market behavior.

I'm not sounding an alarm, but urging caution. Cracks are starting to show, so it is better to be in the markets with caution. Now do I think the rally will end in the coming weeks? No, my reason is a simple one. In a few days we begin earnings season and typically stocks will get a boost. Facebook has done phenomenal in the past few quarters. Even if it misses earnings, the stock will still rally because it is has been in a sustained uptrend.

I would continue to be cautious through the remainder of the year given that this is an election year. I do not suspect the markets to topple this year because the Fed appears to have some political pressure on them to calm the markets even though it is not their job to give a hoot.

Tread Carefully.

*Note for the StockTwits I used the ETFs because they had decent number of followers. For the rest of the article,mentions of the indexes refer to the futures because they trade 24 hours and I feel are better representative of the market.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.