Market Internals Stagnate On Diverging Sectors

by: Ryan Kelly

After a mediocre performance last week, with the S&P 500 managing just a .33% return for the week, are more mediocre returns on the horizon? Can the market get out of its rut and surge past its 2011 highs, or will bears emerge from their recent hibernation on exhausting bulls? We look at the internal behavior of the New York Stock Exchange to gauge its underlying health.

The Facts

The median return for common stock issues on the NYSE was about half of the S&P 500's return, at .15% for the week. The equal weighted average was under half as much as the market cap average, at 21 and 46 basis points, respectively. This performance suggests that small caps didn't manage to net the same gains that larger caps were able to achieve for the week. This is confirmed by the scatter plot that compares market capitalization for each common stock issue against their respective returns. The regression line through the chart makes it easy to view the trend of returns against market cap.

While the trendline isn't incredibly steep, its upward slope shows that larger cap returns performed generally better than smaller cap returns. Activity was slightly lower than last week as measured by dollar volume, with an average of about $106 billion on the NYSE each day this week versus $110 billion last week. The most active day occurred on Thursday's rally, with about $110 billion trading hands on the NYSE. The dollar volume weighted average, a theoretical average that weights each return by how much dollar volume it received for the week, was up just under 40 basis points for common stock issues on the NYSE.

The scatter plot of dollar volume for common stock issues against their weekly returns shows that more liquid issues saw generally better returns than less liquid issues. However, the trendline's slope is very small, showing that the out-performance of more liquid issues was very minor.

The distribution of returns for the week was very symmetrical, moving away from the past trend of right-skewed distributions with heavy positive kurtosis. Kurtosis, or extreme returns, was fairly mild for the week with a numerical value around 10, compared to readings near 20 that have been more common in past weeks. While large positive returns did slightly outnumber their negative counterparts, it was only by about 40% compared to large positive returns being twice as frequent as large negative returns in past weeks.

Note that the two bars on each end represent all returns beyond that point, and are considered to be large returns as they extend far beyond the majority of returns.

The Meaning

The fact that the distribution of common stock issues for the week was so symmetrical is actually slightly troubling. A positive skew (right-skew) to the distribution is actually healthy in a bull market as it means there is more exuberance supporting the bulls. The fact that large returns had similar frequencies is equally troubling. Markets typically don't stay stagnated for very long, and if there are not many positive surprises eventually the bears will take hold of the trend.

The leaders (groups of stocks that typically move first) in the past few years, small caps and the financial sector, did not show the performance we would hope to see in a healthy bull market. While we already displayed small caps performing below large caps, financials were also the weakest sector for the week. Financials' weak performance was supported by the worst performing stocks having generally higher dollar volume.

The stock market was bolstered up this week by strong performance in the energy and technology sectors. We continue expect these sectors, particularly energy stocks, to be strong performers. Energy's leading performance was supported by a very healthy trend of more liquid stocks being the strongest performers.

The trend of supply and demand shows the two beginning to stagnate and remain at roughly the same levels for the past 2 weeks. We measure supply and demand from an intermediate standpoint using various components that take in to consideration activity, intensity, and breadth from stock trading on the NYSE.

While it can be seen that both supply and demand have been on a downtrend since the volatility of last fall, if supply has reached a near term bottom and demand continues to fall we would expect a correction to occur.

The Word

Stagnation was the theme of the week. Unfortunately, free markets like to accelerate and very rarely remain stagnated. Despite the marginal gain for the week, taking a closer look at the internals of stock market behavior shows that the bulls and bears reached a deadlock this week.

Last week saw the bulls stop for a breath of fresh air, and it is now about whether the bears will take this moment of weakness to produce some losses. Either way, there is no evidence currently to suggest the primary uptrend in the stock market is in question. If a correction is to unfold, based on the continuing developments of that data we take from the NYSE, we do not believe it will be severe.

We continue to hold that there is no correction coming, however the evidence for that argument deteriorated after this week. Despite this, we do not recommend any investors to attempt to sell out and time the correction. It is more than possible for the bulls to restart their charge after the hiccup last week and push the market further up without any interruption from the bears.

The prospect of timing a sell out before a correction and a buy in at the trough of a correction is not worth the risk of lost profits during this primary uptrend. Only highly aggressive, short-term traders who feel confident in their ability should attempt this maneuver. All other investors and traders are advised to sit tight and let the trend be their friend.

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