Weekend Update: Bounce Reaches New Highs and the Equal Weight SP500

We now have all the confirmation needed to set the latest swing low in the uptrend. With this week's higher closing high we have a confirmed higher low and the next support for the uptrend. The "hammer candle" that formed from the recent pullback 4 weeks ago has seen bullish follow-through and now a new high. That is exactly what we have been expecting and hoping for when the low was put in early February. Now the stop for SP500 traders is a weekly closing price below the swing low at 1,775-1,782.

Something that I have been watching after it was brought to my attention this week is the SP500 index compared to the Equal Weight SP500 index. The SP500 as most know is a Cap Weighted index, meaning the stocks with the largest market capitalization (AAPL, IBM, GE, etc) have more effect on the price movements of the SP500 than the smaller components within the Index. The SP500 is made up of 500 companies and of those 500 companies, the SP500 index gives more weight to the larger companies. This is fine I suppose from a risk management perspective, but it doesn't give the clearest picture to the actual strength of the 500 stocks. You could have a situation where AAPL (the largest component) has a bad day, yet many of the smaller companies perform well, but the SP500 will trade lower or lag because of that one large stock. It is also observed that in strong market rallies, smaller companies will outperform the larger, safer ones. So just by looking at the SP500 you will not get the most accurate assessment of the actual strength present in the underlying stocks. It is said that "it's a market of stocks", but with the current construction of the SP500 index its really a market of a few big stocks and that's all that mostly matters.

The way around this unequal distribution in the SP500 is to track the index that gives an equal weight to all 500 stocks. AAPL has just as much impact as the smallest companies in the group and gives a better representation of what's really going on under the surface. Again when markets are in Bull mode we like to see small cap stocks outperform the larger ones. This shows good risk appetite from investors and suggests that the more economically sensitive stocks are setup to prosper in the current environment. There is a fantastic post that describes this comparison (here) if you are interested in reading more.

With this idea in mind we will be tracking this Equal Weight index (ticker symbol SPEW-X in Freestockcharts.com). There was a ton of talk early this week about how it was Bearish that the SP500 could not make a new high and how it was about to roll over immediately. Yet if you take a quick look at the Equal Weight SP500 index it made new highs two weeks ago and we now have seen two consecutive weeks of Bullish follow-through to confirm that breakout. The other interesting tidbit with following the SPEW vs the SP500 is that we can apply our Relative Performance chart to the Equal Weight index. This gives us another way to determine the underlying health of the market by looking to see if its Relative Strength is trending higher or lower. When the Equal Weight index is outperforming the SP500 index it means the smaller companies are leading the advance and outperforming vs their larger counterparts. Which if you recall from the last paragraph, is Bullish activity. Let's take a look at the two indexes and compare them to see this positive divergence in the Equal Weight vs Cap Weight.

SP500 (Cap Weighted)

The SP500 finished the week at a new closing high but there was a lot of chatter in the media about this not being a strong attempt to breakout.


SP500 Equal Weight (SPEW-X)

Yet the equal weight SP500 had already made a new high last week and this week we saw continued follow-through on the breakout. Smaller stocks and a more broad advance are fueling this market higher as shown by the SPEW. These are signs of underlying strength and a positive signal that the rally will continue despite its incessant doubters.

Equal Weight Relative Performance vs. Cap Weight

And here is a look at the current rally showing steady outperformance by the broad distribution vs. the top heavy SP500. What is nice to see here is that the equal weight index is once again breaking out and confirming the strong price action.

Taking a look deeper at the Relative Performance vs the price chart, the takeaway from the recent pullback was how the Relative chart put in its pullback low the first week of December, while Price printed its pullback low the first week of February. When price was making a potential breakdown the equal weight index's relative strength was signaling strength building as price weakened. This is what we call a positive divergence. We are now seeing the market play catch up and the divergence is manifesting itself through continued new highs.

This is pretty cool stuff and we will continue to watch these ratios going forward.    


----While the market made new highs, we have a few changes to our holdings for next week:

-PBW (adding 1/3 position, now full holding)

PBW has broken out big, triggering both the short-term and long-term Inverse Head/Shoulder base formations and looks ready to really move. Stops will be placed below the $6.40 closing swing low.

Initial targets for these patterns will be $8 for the short term breakout and $10.40 for the larger. As I stated last week the larger pattern takes precedence for our trade and we will be targeting that objective at $10.40. The current risk/reward for new entries as of Monday's open will be roughly $.75 risk ($6.40 stop) and $3.06 reward ($10.40 target). That means we only need to be correct 1 out of 4 times to break even with this setup. I'll take those odds any day.



-PPG (additional signals showing strength, good add point)

PPG set a new all-time high and this could be a place to put on additional shares if you wished to press bets here. You know you have a winning holding when within its uptrend Price and Relative Strength can setup new signals without invalidating the prior signals. That's strength and strength can be bought.

-UNH (adding full position 3/3 signals)

UNH has broken its consolidation base and is ready to join our Portfolio, we will start UNH with a full position based on confirmed signals from the 20 WMA, RS trend, and base formation breakout. The base target will be $82.50 and initial stops will be placed at $70.45.

-DDD (no changes, 1/3 holding)

DDD announced earnings Friday and here is the trading action that has been created. This is the Daily chart so we can see a zoomed in view of what's really going on here. We can see a large topping formation under construction where if the $68 level fails to hold, we could see a meltdown in this space. However, to keep things interesting, the shorter term view looks to be setting up a reversal base; we will need to see $81 taken out, but if it is we could be likely looking at new all time highs from the measured move. This is a wait and see right now but it will likely show us one way or another what its longer term intentions are soon.

-TLT (no position changes, 2/3 holding)

TLT is attempting another run at a Double Bottom breakout. We will need to see a weekly close above $109.20 to confirm a higher high. Again this is a space to watch closely as Treasuries usually perform opposite to the overall market. If that continues to be the case, a breakout here could be a bad sign for stocks. So far Stocks have confirmed their Bullish stance first as they made new highs this week, it will be interesting to see what Bonds do in the face of the current strength in Stocks. Likely one of these is wrong; it is rare to see both trading higher at the same time, which one is wrong is yet to be seen, but we will likely know soon.

WFC (no position changes, 2/3 holding)

Wells made a new weekly closing high! Yay!

CMI (no position change, 3/3 holding)

CMI made a new all-time closing high too! Yay!


HAIN (no position change, 2/3 holding)

Hain continues to hold support. Stops just under $84