As a short-term speculator, I pay great attention to individual trading days and the intermarket relationships within them. Throughout any given trading day, the flows between different markets can be extremely valuable -- both to short-term speculators like myself and longer-term investors looking to achieve a better entry. My main trading instrument is the S&P 500, so as an index trader I find it very helpful to observe the relationships between the stocks that make up the indexes vs. the index themselves.
Today I noticed a few very powerful indications that there was some internal strength in the stock market. This suggests we may be near the end of this very sharp pullback that has caused the Dow Industrials to drop almost 500 points in the last four trading days.
Small Caps Vs. Large Caps
Small-cap stocks are traditionally viewed as a riskier "risk on" investment as opposed to large-cap stocks. Therefore, we can assume that if small caps are outperforming large caps over any time frame, there is typically a bullish inclination for equities. Today, as large-cap companies sank lower on worsening earnings, riskier small caps outperformed greatly. Below is a chart of the Russell 2000 vs. the S&P 500, thus showing the relative outperformance (or underperformance) of small caps vs. large caps. You will immediately notice that the continued strength in small caps today is apparent.
Click to enlarge images.
Technology Vs. the Broad Market
Another sector of the U.S. stock market that outperformed the broad market was technology, which -- as we know -- has the led the decline lower in the most recent pullback in equities. Below is the relationship between the Nasdaq 100 and S&P 500. If technology stocks are starting to outperform and put in a bottom, that could mean the end of the pullback for the entire market.
Advance/Decline Vs. the Broad Market
Although the market continued to sell off from the open today to close even lower than the open, as the day went on more stocks started turning positive rather than negative. At the start of the session, nearly 2,000 more stocks were negative than positive, whereas at the close of trade only 1,400 more stocks were negative than positive. This tells us that many stocks started turning positive throughout the session, even as broad market selling continued. This occurrence can be represented in the chart below comparing today's action in the S&P 500 (the red line) to the advance/decline index (the black line). This relationship between the stocks that make up the index and the index itself once again shows that positive internals are emerging, pointing to the possible end of this sharp decline.
Is the Equity Pullback Nearing an End?
The simple answer is "possibly." There are many other factors -- including macroeconomic events, sentiment shifts, and market flows -- that can easily continue this sell off lower. However, the three occurrences I have pointed out above tell me that the odds a bottom is forming are increasing. With this in mind, I am starting to turn slightly bullish into this selling with a weighting toward technology.
