Small caps are key to US equities

Although internal breadth is mixed for US equities it’s not at a level of significant concern, says Ari Wald, Technical Analyst at Oppenheimer.

Answering the question from several of his clients about whether the decline in the % of stocks in an uptrend (i.e., those above their 200-day m.a.) should be viewed as a warning for the broader market, Wald thinks that although internal breadth is weaker than it was in 2013, it’s not at a level of significant concern (see S&P 500 chart).

In Wald’s view, there are enough stocks in an uptrend to avoid a broad-based sell off, but stock selection remains critical given this mixed market performance. He lists three points to consider:

1) In the current cycle, market breadth peaked in May 2013 when 90% of the S&P 150 was in an uptrend. At the market’s latest peak, this reading was 71%. However, while participation is lower than in 2013, it’s not as weak as the market’s top in 2007 when this reading was 60%.

2) Weakness has been concentrated in commoditiy and interest-rate sensivite sectors, like Energy and Utilities, vs. broad-based weakness when most sectors were below 70%.

3) The main drivers of this breadth divergence have been lower commodity prices and directionally higher interest rates, both signals that have historically been a net-positive for the S&P 500.

Wald says it would be of more concern if small caps started to weaken. He points out that small caps are an important barometer of risk assets and their ability to hold this year’s breakout, now support, is the most important action on his market radar (see Russell 2000 chart).

Chart of S&P 500 & market breadth
Chart of Russell 2000