Nasdaq is the Leader

The Nasdaq massively outperformed both the SPX and the Russell 2000 last week.  On Twitter, it seems like the paper napkin technicians are suddenly concerned about the weakening breadth out there.  In the distant past, until 2018, breadth was a good predictor of future broader market weakness.  You would see breadth weaken as the market grinded higher, and that would be a reliable signal of an impending pullback.  But things have changed since 2018.  Weak breadth no longer provides a reliable signal.  

Instead, it is strong breadth, with Russell 2000 outperformance, which has become a more reliable signal of an impending pullback.  Russell 2000 has become a barometer of investor exuberance.  Whenever investors feel super bullish, they gravitate towards the more speculative Russell 2000 for the extra juice.  The surge higher in Russell 2000 as the Nasdaq 100 lagged the SPX and Russell 2000 foreshadowed the local top in July.

Nasdaq 100/Russell 2000 Price Ratio

As you can see in the ratio chart above, the QQQ/IWM ratio topped out a few days before the SPX made its top in mid July and early September.  Those happen to be the only 200+ point pullbacks in the past 6 months. 

When the Nasdaq is outperforming the SPX, it is usually bullish for the market.  When the Nasdaq is lagging, it is usually bearish for the market.  What you saw in October and November is an anomaly.  The Nasdaq was noticeably lagging the SPX during that time and the market kept going higher.  You can credit the Trump hype effect for that phenomena.   Investors incorrectly viewed a Trump presidency as being bearish for tech stocks, and bullish for small caps.  Fast money piled into small caps after the Trump win, only to sell when they realized that there were no greater fools willing to pay a higher price for small caps.  Small caps are merely trading vehicles, not something that investors believe in for a long term investment.  They have underperformed large caps because their earnings have underperformed.  The Russell 2000 is merely a sideshow.  The total market cap of the Russell 2000 is about the same as the market cap of AAPL.  That shows you how insignificant the Russell 2000 is to the big picture.  

So the very mild pullback last week is actually a bullish short term sign, with Nasdaq 100 regaining its leadership.  Remember, investors are not going to pay nosebleed valuations for financials, utilities, and other so-called benefactors of the Trump trade.  Those sectors can only go up so much before they flatten out.  You don't get investors excited about momentum building up in low growth names.  You need to see the momentum in mega cap tech and high beta tech to pump the SPX to even more nosebleed valuations.  Investors are willing to pay sky high prices for tech stocks if they are going higher.  They are not willing to pay sky high prices for other, more boring sectors.  

Longer term, the highly concentrated rally focused on tech stocks is a sign of a weakening economy.  But shorter term, its a bullish sign that we're still not at the top of this bull market.  In an interview with the Interactive Brokers CEO last week, he noted the following:  

You can see that over 70% of trading volume is in Mag 7 stocks.  And outside of that, its mostly crypto related companies and cryptos.  That tells you where the individual investors are putting their money.  They are almost all in on high beta and spec names.  Very reminiscent of late 1999 and 2000, but that's a story for another day.  

You will not see real pain in the overall stock market until you see Nasdaq 100 really underperform.  The US economy is now extremely financialized.  With the heavy allocation to equities among households, and in particular megacap tech, a Nasdaq 100 bear market would cause a reverse wealth effect, slowing consumer spending, leading to an economic slowdown.  That's not something on many investors' bingo cards for 2025 and 2026. 

Not much movement in the CFTC COT positioning for the major stock indices, with asset managers and small speculators remaining heavily long.  You continue to see lots of call buying on the ISE.  There is a lot of options speculation in individual names, in particular TSLA.  With just 2 weeks till the end of the year, I would expect the recent big gainers to hold their gains as many investors will want to delay capitals gains into 2025.  That is also part of the reason that you are seeing Russell 2000 underperform, as many small caps are tax loss candidates. 

While the Nasdaq 100 strength was a bullish factor last week, the suddenly weak bond market and rise in yields was a bearish factor.  If you consider both, the current situation is about neutral.  I did cover some of my shorts on Friday, and now only hold a very small short position which I will likely close out today.  With volatility staying low even during last week's pullback, that is a good sign for the bulls.  A market that doesn't want to selloff much even with such bullish positioning makes it tough to stay short for long.  Just a 1% pullback, and even that's been a struggle to get for the bears.  On the short side, you have to take your points when they come and not get greedy.  The pullback started last Monday, so its on day 6.  I doubt the market can go down much more this week before bouncing again.

I don't see much edge at current levels, with bullish seasonal factors about to really kick in as we get closer to Christmas.  The opex forces from triple witching coming up this Friday could induce a bit of volatility as institutions do some last minute position squaring and year end hedging before the holidays.  But its not worth betting on much movement this time of year.  The complacency and lack of fear, high amounts of call buying, and heavy bullish positioning are potentially bearish elements.  But its been that way since the election, and still we grind higher.  Nothing compelling here, although if we do get a further move down towards SPX 6000 this week, it could be worth a small long play to ride the seasonal tailwinds.