Equal Weight S&P500 vs. Market Cap Weight
- The S&P 500 (SPX) made a new closing high last week but pullbacks and consolidation often follow new highs. We have been upgrading recently into higher quality, large cap and mega cap tech and growth stocks, to complement our longer-held cyclical positions.
- We continue to believe that both tech/growth and cyclicals can continue to outperform at the same time, but we believe that the market is going to continue to shift from more speculative/unprofitable companies into the higher quality tech/growth stocks at more reasonable valuations.
- Despite the chop in the market for growth stocks this last few weeks, and the likelihood of short term market volatility, the chart below depicts why we remain bullish for 2021.
- The middle pane of this chart is the ratio of the Equal Weight S&P500 (SPXEW) vs. the regular S&P500 (SPY) . The bottom pane is the SPY, or regular S&P500. In SPY the index is weighted by the size of the company so the big companies have an overpowering impact on the market. In SPXEW, each stock has the same weight. As an example of what a difference this can make, during the 2000 bear market, while the SPY was down about 50%, SPXEW was down roughly 25%. It was a big cap, big tech bear market.
- So when the ratio is rising, it means that stocks of small companies are outperforming the big ones, or at least it means that they are keeping pace. This is generally a sign of a healthy market, when more companies are rising. If it’s only the generals on the field and the soldiers aren’t helping, it’s a sign of a weak army.
- Where it gets interesting is the upper pane, which measures the momentum of the ratio SPXEW/SPY. This is called the RSI index. It ranges from 0 – 100. Generally when it goes above 70 it’s a sign of strength and when it drops below 30 it’s a sign of weakness, which indicates that the smaller stocks have an extreme level of weak relative strength.
- Each time it dropped below 30 since 2006 it marked a high risk time in the market, indicated by the red lines.
- You can see most recently that it dropped below the lower threshold in January 2020 and has returned back to levels indicating market strength.
No indicator is perfect, nor should they be interpreted on their own, but this ratio does a pretty good job and supports our Primary Trend Indicator inputs that demonstrate, aside from some short term issues, we expect higher highs this year.