By Jon D Markman
Digging beneath the surface of the late 2009 market for clues, we find that some measures of breadth continue to deteriorate even as the major indices continue to float near their highs. For example, the percentage of stocks above their 10-day moving average has gone from 81% on Christmas Eve to 71% now. This is an indication that buyers have become more selective.

This adds to a trend that's been developing over the last few months. While the NASDAQ has managed an impressive breakout from its multi-month trading range, it's doing this on the back of fewer and fewer stocks based on the number that are over their 50-day moving average. Part of the problem is the lack of clear market leadership.

One of the reasons that the bull cycle of the past year has been so strong is that it had a rotating cast of leaders: First banks, then retailers, then tech, then energy, then materials, and so on. Right now, aside from today's impressive move in semiconductors and possible early signs of strength among brokerage stocks, there isn't any major sector group rearing back like it's about to enter a new upswing. Materials and energy looked really strong until about two days ago as traders seemed to decide the dollar's resurgence isn't a short-term wiggle but the beginning of something bigger.

If the bulls are going to push a group higher, they need to hurry up and get the job done as the broad market looks increasingly top heavy. We can't make any hard-edged decisions at the moment with volume so light, but we'll be watching closely for clues when the market comes back early next week about which sectors and which stocks are likely to Lead the charge in early 2010. My expectation at this point is that tech, and particularly semiconductors, will assert a leadership role. If that does happen, it will be a huge positive for the whole market.

Small Caps Have Fuel to Burn
Market gains in the last two weeks of the year were driven overwhelmingly by a withdrawal of selling pressure rather than an increase in buying demand. According to Paul Desmond of Lowry Research, his gauge of buying power increased just 4 points in December compared to the 24 point drop in his selling pressure measure.

We'll be looking for evidence of improved demand as the calendar flips into January. It tends to be one of the strongest months of the year for the smaller, riskier stocks in the NASDAQ and Russell 2000 indices. Gains here should force institutional investors off the sidelines. Based on 30 years of historical data compiled by Jeffrey and Yale Hirsch, the father and son team behind the Stock Trader's Almanac, small stocks tend to outperform strongly between December and March with a small pause in mid-January.


Buy and sell commodities online

It's possible that the pause we saw in December was a time-shifted January pause. As these seasonal patterns are more widely recognized, they move back in time as traders try to capitalize on them early. Eventually, they can disappear completely for a time just to throw everyone off the scent -- which frequently happens with the 40-week cycle that we have frequently discussed.

Another factor to consider is that at the start of all the major bull markets of the last 30 years, smaller stocks significantly outperformed larger, safer stocks during the earliest phases before large caps assume the leadership role as the upswing matures. It happened in the early 1980s. It happened in the early 1990s. It happened in 2003 through 2005. And it appears to be happening again now.

Evidence suggests that this small-cap outperformance is far from finished in the current cycle. Take a look at the chart above. What you are seeing is the 13-month (purple line) and the 34-month (red line) moving averages for the relative performance of the Russell 2000 small cap index to the Dow Industrial Average large cap index. Coming out of both the 1991 and 2001 recessions, the 13-month line moves well over the 34-month line as smaller stocks pushed upward, in a sign of strong momentum.

Post your comment  (0)

Connect:

Post to Twitter

Post to Facebook