The latest bearish meme is the focus on market divergences. The idea is that a “healthy” market shows confirmation from various sectors. The Dow made a new record high this week, which does not really reflect the overall market. Many smaller stocks have experienced a significant decline from their highs.
In a week that will have fewer earnings stories and less important economic data, I expect many to ask, “Should we be worried about divergences?”
Prior Theme Recap
Last week I expected a focus on the Ukraine crisis. My main idea is that it is important for citizens but not really a market crisis. The muted impact from news last week provided some support for my thesis, although there were clearly some intra-day moves attributed to news from the region. The impact on Russian stocks is certainly important.
It proved not to be a primary theme, but the idea of fading this “news” is still sound.
Forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along with the “theme forecast.” I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think.
Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.
This Week’s Theme
What is a divergence and should we worry about it?
Josh Brown cites Peter Boockvar who warns as follows:
You don’t typically want to see large caps struggling at recent highs with less underlying participation by individual stocks – narrowing of participation at highs is how tops are formed. You also don’t typically want to see new all-time highs for the S&P while the more economically sensitive small caps are in a correction. These things can resolve in either direction, but the historical bias is toward a resolution to the downside.
Josh, open-minded about the final resolution, illustrates the divergence between the Russell 2000 and the S&P 500 with this chart:
Is the divergence a cause for concern? Boockvar does not really provide any evidence about small caps being more economically sensitive, nor about how divergences are usually resolved. Here are some other viewpoints.
- The average stock is already in a bear market. Sam Ro cites J.C. O’Hara, who echoes Boockvar’s message about “masking internal weakness.”
- It is a rotation, emphasizing dividend stocks (see Bespoke).
- It is a rotation, resulting from pension fund reallocation (via Cam Hui).
- You see what you are looking for with trend lines. Greg Harmon has good charts and examples.
As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.
Last Week’s Data
Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:
- The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially — no politics.
- It is better than expectations.
The Good
There was little news, but it was mostly good.
- ISM services increased to 55.2. That is the highest level in months. Read Doug Short’s complete report for discussion of the underlying components and additional charts. Here is the headline series:
- The quit rate is higher. There is some really bad analysis of the JOLTS report. Those who change their choice of indicator with the wind have thousands of choices. I emphasize the quit rate as the most important aspect of this report. It is not as good as other methods for analyzing overall job growth or unemployment. It is focused on turnover. The number of those voluntarily leaving their jobs is a good indicator of market health, and one that most do not know. 2.5 million people voluntarily quit jobs in February, the highest number since July, 2008. Nick Timiraos of the WSJ has anice analysis with good charts. Here is the quit rate:
- Initial jobless claims declined to 319K. This relieved some concern about the recent spike in this noisy, but important weekly series.
- Hotels are on track for the strongest year since 2000. Calculated Risk reports the details – not surprising to this traveler!
- Sentiment has turned bearish (a contrarian indicator). Bespokehas the story.
