Nasdaq 100 Relative Strength

Nasdaq 100 (NDX) Relative Strength

A friend and respected colleague reminded me yesterday that he essentially believes that the SP500 Double Top scenario is unlikely because of NDX strength. My response was, "I hope you're right", which I do. I'd very much prefer to be horribly wrong and simply adjust as I always do when I'm wrong. I too believed that the SP500 lows would hold. They were unconfirmed by pretty much every measure including NDX confirmation. I thought once the Stimulus bill passed, Congress and the President would essentially turn into economic cheerleaders and we'd be looking at a major market bottom.

The chart above is the NDX divided by the SP500 on a weekly basis (NDX/SPX).

This represents the strength of the NDX compared to the SP500. As you can see, the action since 2006 has been bound in a well-defined uptrending channel. We've touched the upper bound of this channel during the weeks ending, 1/17/06, 11/5/07, 8/18/08, and this week. All three previous points were followed by significant drops in the NDX. The 11/5/07 case was the very top of the last bull market. The 8/18/08 case was a smaller top just before the bear market really got going strong to the downside. After the 1/17/06 case, the NDX dropped 17.4% while the SP500 only dropped 4.6% which was more of a change in asset flow as opposed to a huge market sell-off.

So what does that mean for today?

As you can see in the chart, so far 2009 NDX/SPX has moved straight up to R1. A lot of traders and active asset allocators watch this chart. The 2009 move may be simply self-fulfilling. Ie. once NDX/SPX touched S1, that was a popular signal to move into NDX type assets expecting a move to R1. That opinion was so popular among big players that NDX/SPX simply moved straight up. If the 2009 NDX relative strength is simply a self-fulfilling pattern, it may be falsely indicating accumulation of higher risk assets (NDX) which is a common indication of a major market low.

Another exciting possibility

The straight up move in 2009 may truly indicate massive accumulation of NDX type assets due to other fundamental factors. If so this is very bullish for the overall market. In fact, that spectacular move into NDX type assets may have exaggerated the selling in the SP500 and Dow Jones Industrials. This may mean that the SP500 breakdown confirming the Double Top may have been somewhat due to unusual money flow similar to what occurred in the 2000 bear market. Back then, the spectacular flow of capital into bonds skewed all indications based on NYSE breadth because of the addition of so many NYSE listed bond funds and ETFs. Historically, NYSE breadth would reveal stock liquidation but because that liquidation was simply moving into other NYSE issues (bond funds and bond ETFs), it was hidden. This is an exciting possibility and obviously the case for which I'm hoping.

How to play it.

Personally, I'd move out of NDX based assets into market strength as I believe there will be at least some downward correction of NDX/SPX off R1. If the massive accumulation case actually exists, that correction should be short-lived and NDX/SPX should move sideways as the rest of the market gets into bull market mode. Or NDX/SPX could even continue to move higher taking out R1 as bullish investors accelerate buying of battered tech stocks. This will be an important clue to me as I consider whether the short-term market rally I expect appears to be a dead-cat bounce in a bear market, or the start of an Obama Bull Market.