#$qqew

Here are some of the most noteworthy highs and lows from across the markets for Friday, June 5, 2020.

NYSE Advance-Decline Line Back At All-Time Highs

Equal Weight Nasdaq 100 $QQEW Back At All-Time Highs

The Home Depot $HD Back At All-Time Highs

Semiconductor Index $SOX Passes Test, Rebounds Back To All-Time Highs

If you’d like to see these charts as they come out in real-time, follow us on Twitter and StockTwits. And if you’re interested in the daily “all-access” version of all our charts and research, please check out our site, The Lyons Share. You can follow our risk-managed investment process and posture every day — including insights into what we’re looking to buy and sell and when. Thanks for reading!

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Equally weighted stock averages are attempting to regain key ground.

Last July, we noted a potentially troubling development in the midst of what was a rip-roaring rally at the time. Stock averages like the Nasdaq, and even the small-cap Russell 2000, were setting all-time highs on an almost daily basis -- and the Dow Jones Industrial Average and S&P 500 would not be far behind. However, as we pointed out in the post, on an equally-weighted basis the rally was not quite as robust as it appeared.

Once again, as the name implies, the equal-weight average weighs each of an index's components the same. This is in contrast to more popular weighted averages like the S&P 500 and Dow which place more weight on larger or higher-priced stocks. Price or cap-weighted averages can give one a distorted view of the health of the broad market at times if they are being unduly influenced by a relatively small number of stocks. On the other hand, an equally-weighted index can give us a better sense of the level of participation across the entire index. And a higher participation level equates to a healthier rally.

In late July, we pointed out that, on a relative ratio basis, the Invesco S&P 500 Equal Weight ETF (ticker, RSP), had just dropped to a 5 1/2 year low vs. its cap-weighted counterpart, the S&P 500 SPDR ETF (SPY). Similarly, the First Trust NASDAQ-100 Equal Weight ETF (QQEW) had just dropped to an all-time low vs. its cap-weighted counterpart, the Invesco Nasdaq 100 Trust (QQQ). In our view, this was a red flag since we prefer the equal-weight average to be leading the way as a show of broad participation. Indeed, the broad market would top out within a month and the large caps within 2. And we're all aware of the ensuing damage that occurred in the 4th quarter.

Fast forward to today. Encouragingly, by looking at the ratios again, we see that the equal-weight indices have been leading the way during the recent bounce off of the December lows. Also encouragingly, the ratios are attempting to recover their respective breakdown levels from last summer.

So if these equal-weight ratios recover their breakdown levels, does that mean that stocks are in the clear? And what's the practical application of this analysis? In a Premium post at The Lyons Share, we share our objective strategy for dealing with this weighty development.

If you are interested in an “all-access” pass to our research and investment moves, we invite you to further check out The Lyons Share. Given an treacherous emerging market climate, there has never been a better time to reap the benefits of our risk-managed approach. Thanks for reading!

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Formerly lagging equal-weight indices are attempting a comeback — a development which would bolster the odds of a significant rally.

This past summer, we began detecting signs of a thinning out of the U.S. equity rally, a trend which would eventually contribute to the recent market correction. One manifestation of that internal weakening was seen in the various “equal-weight” indices that we track, as noted in a late July post.

As the name implies, the equal-weight average weighs each of an index’s components the same, in contrast to popular cap-weighted indices which place more weight on larger stocks. Cap-weighted averages can give one a distorted view of the health of the broad market at times if they are being unduly influenced by a relatively small number of stocks. On the other hand, an equally-weighted index can give us a better sense of the level of participation across the entire index.

The benefits of widespread participation (and vice versa) can be seen in a ratio of an equal-weight index to its cap-weighted counterpart. For example, see this chart of the performance of the Invesco S&P 500 Equal Weight ETF (ticker, RSP) vs. its cap-weighted counterpart, the S&P 500 SPDR ETF (SPY). As you can see, when the ratio was heading higher (i.e., the equal weight RSP was out-performing), stocks trended higher. However, when the RSP has declined on a relative basis, we have tended to see the stock market suffer — as it has over the past several months.

We can see the same general tendency in the ratio between the First Trust Equal Weight Nasdaq 100 ETF (QQEW) and the cap-weighted Invesco Nasdaq 100 ETF (QQQ). Though, given the overall dominance of the QQQ over the last dozen years, it is easier to see the benefits of the QQEW when the ratio is rising, e.g., coming off of the 2009 low and during the 2013 surge.

Unfortunately, as we mentioned, the equal-weight indices have struggled on a relative basis for most of the year, foreshadowing the recent rough patch in the market. However, they are presently attempting to stage some positive progress toward erasing at least the most recent deterioration suffered over the past several months. To wit…

In the July post, we mentioned that the RSP:SPY ratio was breaking down to new 5-year lows, below the former lows from 2016 and early 2018. That opened the way to a more accelerated decline in the ratio — and the swift recent selloff in the market as as whole.

At present, however, the RSP:SPY ratio is attempting to reclaim that breakdown area, a development which would likely be a sign of improving internals — and perhaps a tailwind for the market.

We are seeing a similar development in the QQEW:QQQ ratio. In this case, back in May, the ratio dropped below a trendline connecting (and supporting) a series of lower lows in the ratio going back to 2008. This too led to a swifter decline in the ratio, contributing to the recent sharp declines in the Nasdaq and technology sector.

However, as with the RSP, the QQEW:QQQ ratio has jumped in recent weeks and is challenging its former breakdown level.

Now, at times, these equal-weight ratios can see swift improvement during portions of a market correction when market participants begin to punish the largest caps to “catch up” to other stocks to the downside. However, in this case, the relative improvement in the equal-weight indices has occurred since the initial correction low in late October. That gives us some measure of optimism that this latest improvement in the broader market is legit.

The key, though, is what transpires at the breakdown levels of the respective ratios. Should they decisively reclaim the former breakdown levels, it should be a good sign for stocks in the short to intermediate-term. Should they fail here and resume their downtrends, it would be a sign that all is still not healthy in the broader market. We will continue to monitor these developments and provide updates in our AM Daily Strategy Sessions at The Lyons Share.

If you’re interested in the “all-access” version of our charts and research, please check out our premium site, The Lyons Share. You can follow our investment process and posture every day — including insights into what we’re looking to buy and sell and when. Given what we believe will be a treacherous market climate going forward, there has never been a more important time to reap the benefits of our risk-managed approach. Thanks for reading!

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On an equal-weight basis, the Nasdaq 100 just dropped to a relative all-time low.

There are many ways to measure the level of participation, i.e., the number of stocks that are taking part, in a stock market rally. One way is to look at the market’s “internals”, e.g., advances vs. declines, new highs vs. new lows, etc. As an indication of good quality participation, we like to see a high number of each of the former vs. each of the latter. Another way of measuring participation is by looking at indices on an equally-weighted basis instead of a cap-weighted basis. In the latter, an index may remain propped up by a relatively few number of stocks, if they are among the largest and most heavily weighted in the index. When that is the case, the market may be susceptible to weakness since it is being supported by just a relatively small number of issues. It could be argued that that is an apt description of the soaring Nasdaq market rally at present.

Why do we say that? As displayed in today’s Chart Of The Day, the equally-weighted Nasdaq 100 is now badly lagging the cap-weighted version. In fact, the relative performance of the First Trust Nasdaq 100 Equal Weight ETF (QQEW) just hit an all-time low when compared with the cap-weighted QQQ ETF.

Now admittedly, the inception of the QQEW was in 2006, so an “all-time” low is really just an 11-year low. Even still, that equates to more than a decade of data containing all variations of market environments. Furthermore, as the chart shows, the relative ratio hit proximate lows in 2008, 2012 and 2015-2017. Thus, the recent break to all-time lows does capture our attention.

But how threatening is this development? Is it really just a reflection of the overwhelming strength on the part of the Nasdaq's mega-cap "generals", like Amazon (AMZN), Microsoft (MSFT) and Alphabet (GOOGL)? Or is it a genuine warning of deteriorating participation among the "troops"?

In a Premium Post on The Lyons Share, we look at the broad spectrum of evidence to determine whether this development is a concern at this time -- and what we are doing about it.

If you’re interested in the “all-access” version of our charts and research, please check out our new site, The Lyons Share. Considering what we believe will be a very difficult investment climate for perhaps years to come, there has never been a better time to reap the benefits of our risk-managed approach. Thanks for reading!

Related: June 29 “SPECIAL REPORT: Tech Wreck” (PREMIUM-UNLOCKED) — in which we picked off the NDX and tech sector at essentially the very lows of the tech wreck.

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On an equal-weight basis, the Nasdaq 100 just dropped to a relative all-time low.

There are countless ways to measure the level of participation in a stock market rally. By “participation”, we are referring to the number of stocks that are taking part in the rally. One way is to look at the market’s “internals”, e.g., advances vs. declines, new highs vs. new lows, etc. As an indication of good quality participation, we like to see a high number of each of the former vs. each of the latter. When that is not occurring, even as the indices hold up well, we say that the rally is “thinning”, or seeing a decreasing level of participation. We’ve published multiple examples of this internal weakness in recent weeks.

Another way of measuring participation within a rally is by looking at indices on an equally-weighted basis instead of a cap-weighted basis. In the latter, an index may remain propped up by a relatively few number of stocks, if they are among the largest and most heavily weighted in the index. When that is the case, the market may be susceptible to weakness since it is being supported by just a relatively small number of issues. A couple of them go by the wayside, and the market does not have that broad support to compensate. One of the current rally leaders may be falling into such a predicament now.

There is no doubt that tech stocks and large-cap growth stocks have been among the relative strength leaders during this bull market, especially throughout 2017. However, as we see in today’s Chart Of The Day, the durability of that leadership may be at risk, if we can consider the Nasdaq 100 (NDX) as representative of those stock groups. The reason we say this is because the equally-weighted NDX is now badly lagging the cap-weighted version.

Specifically, the relative performance of the Nasdaq 100 Equal Weight ETF (QQEW) just hit an all-time low when compared with the cap-weighted QQQ ETF.

The inception of the QQEW was in 2006, so an “all-time” low is really just an 11-year low. Even still, as the chart shows, the relative ratio hit proximate lows in 2008, 2012 and 2015-2017. The recent break below those levels is not, in our view, a trivial event. But how threatening is this development -- and how immediate a threat?

In a premium post at The Lyons Share, we address those questions as they pertain to the equal-weight QQEW, the cap-weight QQQ and the market in general.

If you’re interested in this “all-access” version of our charts and research, we invite you to check out our new site, The Lyons Share. Thanks for reading!

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A look at the Equal Weight S&P 500 has something for both the bulls and the bears.

A hot, and much debated, topic of late in equity market circles is the issue of market breadth. As a refresher, breadth refers to the level of participation among all stocks in the market, i.e., how many stocks are advancing vs. declining. Many market watchers contend that breadth is an important component when determining the well being of the stock market at a given time. Indeed, various, measures of breadth form the bedrock of our own intermediate-term risk model. After nearly 50 years of observing, we firmly believe that an accurate assessment of the market’s internals, or breadth, is key in determining the true state of health of the broad stock market. Specifically, we view a relatively large number of advancing stocks (i.e., good participation) as desirable, and often mandatory, when considering a healthy, sustainable rally.

The challenge therein is selecting the right measures, and accurately interpreting said measures. That’s because there are about as many ways of measuring the level of stock participation in the market as there are stocks in the market. That’s why the breadth issue has been such a hotly debated topic of late. A solid case can be made in favor of good breadth presently (e.g., A-D Lines at highs, broad indices near highs, etc.) or against it (e.g., non-confirmation of stocks above moving averages, waning relative performance among equally-weighted averages, etc.).

Where do we stand? We certainly see signs of waning breadth, most importantly among some of our key proprietary indicators. However, we don’t yet observe the dangerous “thinning” conditions that can threaten the long-term stability of the market.

In this post, we’re going to look at a couple angles pertaining to one of the aforementioned equally-weighted averages. Specifically, it is the Guggenheim S&P 500 Equal Weight ETF, ticker, RSP.  As the name implies, an equal-weight average weighs each of the components the same. This is in contrast to popular cap-weighted averages, like the S&P 500, which place more weight on larger stocks. Cap-weighted averages can give one a distorted view of the health of the broad market at times if they are being unduly influenced by a relatively few number of stocks. On the other hand, an equally-weighted index can give us a better sense of the level of participation across the entire index.

Here, we look at a few of the pros and cons that we see presently in the equal-weight S&P 500 (RSP)

Pro

As recently as Tuesday, the RSP closed at an all-time high.  Contrary to what anyone might tell you, an all-time high is not a bearish condition.

Con

Despite the all-time high, on a relative basis, the RSP has been trending lower vs. its cap-weighted counterpart since early December. This may be a concern given what we said about good participation been a required condition for a sustainable rally. Indeed, since the inception of the RSP in 2003, the stock market has tended to struggle when the ratio of the equal-weight RSP was trending lower vs. the cap-weighted S&P 500.

  Maybe Con

You see us write often about the Fibonacci sequence, a mathematical series of numbers representative of repeated patterns in all walks of life, including financial markets. Typically, it is terms of Fibonacci Retracements, i.e., the magnitude of counter-trend moves consistently exhibited by market prices. We have also found the sequence useful in Fibonacci Extensions. These describe the magnitude of “extensions” often exhibited following complete reversals of market moves. For example, the RSP is presently hitting key Fibonacci Extensions following reversals of prominent declines over the past few years. Namely, they are the 161.8% Fibonacci Extension of the 2015-2016 decline and the 261.8% Fibonacci Extension of the August-November 2016 decline.

Now, these Extensions aren’t foolproof.  That is, they are not guaranteed to stop the RSP in its tracks. However, we have found this tool reliable enough to be useful in practice, and to be a genuine concern in this situation. And we have found these Extensions, like Retracements, to be particularly effective when clustered together as these two are here.

So, there you have an analysis of current market breadth from the viewpoint of the equal weight S&P 500 Index. It is by no means an exhaustive look at the index, or certainly breadth in general. Like we said, there are untold numbers of ways to assess market breadth. Even, in the case of the RSP, there are numerous ways to assess its situation.

What is our conclusion? From the angles we looked at, like our more extensive assessment of the market’s internals, we don’t feel that a concrete conclusion can confidently be made either way. There are legitimate concerns, but certainly enough positives to consider as well. The best we can say is that the situation needs to continue to be monitored.

It is also a helpful reminder to always keep an open mind about potential market outcomes -- and to always consider the weight of all the evidence in one’s assessment.

If you want the “all-access” version of our charts and research, we invite you to please check out our new site, The Lyons Share.

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The “equal-weight” S&P 500 has dropped to near 3-year lows versus the cap-weighted version. Previous such events under similar conditions occurred at inauspicious times.

Continuing with the impromptu weekly theme regarding the relatively “thin” nature of the recent stock rally, today we take a look inside the S&P 500. Like yesterday’s post on the consumer discretionary sector, this one examines the “equal-weight version of the index versus the traditional cap-weighted version. Whereas the performance of the cap-weighted index can be subject to undue influence by the very largest components, a look at the equal-weight version can give us an idea of the health of the broad swathe of stocks within the index.

While the relative under-performance on the part of the equal-weight S&P 500 (as judged by the Rydex Equal-Weight S&P 500 ETF, RSP) may not be as egregious as in the consumer discretionary sector, it is still somewhat alarming. Despite the cap-weighted S&P 500 (as judged by the S&P 500 SPDR ETF, SPY) being reasonably close to its all-time highs again, the equal-weight:cap-weight ratio has dropped to near 3-year lows. Considering the context, the RSP:SPY ratio is at levels only seen just prior to substantial declines in July and back in 2007.

By “considering the context”, we mean that the cap-weighted S&P 500 is less than 3% from its all-time high. The only months, historically, that have seen the equal-weight:cap-weight (RSP:SPY) ratio at a 2-year low under those circumstances are shown below. Obviously, these did not mark the best months to be buying stocks.

 September-November 2007

July 2015

October 2015

Again, like we have mentioned throughout the week, this situation means that the inordinate bulk of the lifting during the recent rally is being done by the biggest of stocks. It does not necessarily mean that the rest of the stocks are falling or doing poorly. It just means that they’re not doing their fair share. As it turns out, on an equal-weighted basis, the indices have basically been drifting sideways during the most recent few weeks while the biggest stocks have been rallying smartly.

So is this a big deal? Well, in July it was. And in the fall of 2007 it was. Does this mean the market is on the verge of another collapse? Not necessarily. It doesn’t even mean that the rally cannot continue, for a time. It does mean that if one wants to participate on the long side, they are likely better suited being in those relatively few stocks or areas that are carrying the market at the moment.

That said, we are big proponents of good breadth as a sign of a healthy market. The more stocks that are participating in a rally, the better the foundation for the rally. Thus, when some, or a lot, of stocks invariably fall by the wayside, there are enough strong stocks to continue to carry the burden. When there are relatively few stocks doing all the heavy lifting, there is less margin for error.

Eventually, the weight will become too much to bear for just those few stocks. And, as we saw this summer, when those relatively few leaders begin to stumble, the market will again be vulnerable to significant damage.

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More from Dana Lyons, JLFMI and My401kPro.

This piece originally appeared as the August issue of the J. Lyons Fund Management, Inc. Newsletter at www.jlfmi.com.

Over the past few months, we have detailed the systematic deterioration in the internals of the stock market. This trend recently reached depths historically seen only near major market tops.

This is Part 1 of a 1 or 2-Part series on factors that are characteristic of a cyclical top in the stock market. It should really be a 3-Part series but, like Star Wars, we skipped over the 1st part of the story. Part 1A would have covered what we term the “background” conditions of the market. These background conditions -- including valuation, sentiment, stock allocation, long-term price vs. trend, etc. -- convey the general market environment that exists. These conditions are not catalysts or actionable indicators. Rather they reflect the market’s backdrop, instructing us as to which cyclical trends are likely to develop, at some point. Now, the status of these background conditions can persist -- and for a long time. Indeed, we have been discussing the overbought/extended/high-risk nature of various of these indicators for years already. So, in a way we have covered the true Part 1 of this “Market Top” series, just not in a formal sense (our October 2013 Newsletter may have been the closest to an actual “Part 1”).

This piece covers the “internals” of the stock market. Internals (or breadth) refer to the level of participation among stocks throughout the entire equity market. It includes metrics like the number of stocks that are advancing versus declining, the amount of volume in advancing stocks versus declining stocks, the number of stocks that are making new 52-week highs versus new lows, etc. In our view, strong internals, i.e., widespread participation among stocks, is an important ingredient of a healthy market.

As a bull market ages, it tends to “thin out”. That is, it advances despite an ever-decreasing level of participation among all stocks. This thinning can persist for a while, and is not necessarily an immediate threat to the existence of the bull. However, eventually this “divergence” comes to a head as the relatively few (usually mega-cap) stocks still carrying the market higher are unable to continue to do the heavy-lifting. And when those stocks roll over, the foundation among the broad market of stocks does not exist to prevent a significant decline. This end-game development among the internals is quite possibly in motion as we speak.

Does this mean the end of the bull market is near -- or here? Not necessarily. No one can know that and we are not going out on a limb to make such a call. However, the deterioration in market internals has reached truly historic depths – the kind typically associated with cyclical stock market tops. Over the past few months, we have systematically journaled on our blog the veritable procession of breadth failures. Here is a sample of the profusion of evidence that we noted.

Disclaimer: While this study is a useful exercise, JLFMI's actual investment decisions are based on our proprietary models. Therefore, the conclusions based on the study in this newsletter may or may not be consistent with JLFMI's actual investment posture at any given time. Additionally, the commentary here should not be taken as a recommendation to invest in any specific securities or according to any specific methodologies.

NYSE Advance-Decline Line: The Grand-Daddy of Breadth Indicators

In our view, the grand-daddy of all breadth indicators is the NYSE Advance-Decline Line (A-D Line). The A-D Line is a cumulative running total of the differential of advancing stocks minus declining stocks on the NYSE on a daily basis. If we could have just one breadth indicator for purposes of analyzing the cyclical state of the stock market, it would be the NYSE A-D Line. It provides as good a picture as anything of the health of the broad market. And recent developments here do not paint a picture of good health in the market.

For one, on May 27, we noted that the NYSE A-D Line suffered a breakdown below its UP trendline from the 2009 low.

While similar trendlines for most indices remain intact, it is not unusual for the A-D Line to suffer a breakdown first. It has often preceded breaks in the major averages, serving as a warning sign that all is perhaps not well. Note similar warnings prior to the past 2 cyclical tops.

Secondly, while the trendline break was a red flag, it wasn’t the first warning sign to appear in the A-D Line – nor was it the most significant. That distinction goes to the development we noted on May 21. Specifically, the NYSE A-D Line failed to confirm the new 52-week high in the S&P 500 earlier that week. That is, the index made a new high while the A-D Line failed to do so. This is what we call a negative divergence.

So why is this significant? As mentioned in that post, the NYSE A-D Line has negatively diverged before every single cyclical market top since 1966. Now most of the prior divergences had significantly more lead time than this one. However, there have been other close-range divergences so this would not be unprecedented. That said, it would not be out of the question to see the S&P 500 eventually make another higher high concurrent with a more prominent divergence in the A-D Line.

New Highs-New Lows: Cyclical Breakdown

Another of the most popular gauges of market internals relates to the number of stocks making New 52-Week Highs or 52-Week Lows. One way to track the data is to simply subtract the number of New Lows from New Highs on a daily basis. This series tends to trend over a cyclical cycle, thus providing us with signals of various significance based on the series’ behavior.

This New Highs-New Lows indicator has been in an uptrend, in terms of higher lows, since it bottomed in 2008. However, as we pointed out in an August 21 post, like the A-D Line, this metric has also suffered a noteworthy breakdown, falling below that post-2008 Up trendline.

It is possible that this breakdown is occurring within the context of an intermediate-term washout. After all, the August 21 low reading occurred partly as a result of ZERO New Highs on the NYSE. That is a development normally only associated with a capitulatory phase of a major decline (indeed, of the prior 50 Zero New High days, the S&P 500 has been a median 31% below its 52-week high, versus the current 7.5%). Therefore, the market may possibly see a mean-reversion bounce soon. However, the bigger-picture ramifications should not be missed. Similar trend breaks have ushered in an eventual acceleration in losses during the prior 2 cyclical declines.

The Junkie Market: Too Many New Highs AND Lows

NYSE

While we just witnessed an extreme low number of New Highs (e.g., 0), another recent ominous development pertained to the abundance of New Highs and New Lows. Whatever the reason for this dynamic, such conditions have occurred at less than auspicious times. On July 16, we noted the occurrence in recent days of more than 100 New 52-Week Highs AND 52-Week Lows on the NYSE.

Historically, this development in the market’s internals has not been kind to the market going forward.

This was especially true when coming off of a recent 3-month low.

Nasdaq

On July 27, we noted the same situation on the Nasdaq exchange.

These events were similarly unkind to the Nasdaq market, especially the past 5 such occurrences.

NYSE AND Nasdaq

On August 7, we highlighted those occasions in which the NYSE and the Nasdaq exchanges each saw an abundance of both New Highs and New Lows.

As expected, the forward returns in the S&P 500 were quite depressed following these occurrences, particularly in the longer-term.

The Summation Of All Fears

Another way of measuring the cumulative state of market internals is via the McClellan Summation Index. The Summation Index is actually an oscillator that expresses the longer-term status of advances-declines, new highs-lows, etc. as either positive (above a zero line) or negative (below the zero line). While it is an oscillator, the Summation Index can, and usually does, remain positive for an extended period during favorable markets and negative for an extended period during difficult markets. Thus, it is fairly atypical of the McClellan Summation Index on either the NYSE advances-declines or the NYSE New Highs-New Lows to go negative when the S&P 500 is close to its 52-week high. It is especially unusual to see both of them below the zero line with the S&P 500 near its highs.

Yet, as we noted on July 30, this was precisely the situation in recent weeks. This may be the single most instructive chart in illustrating the deteriorating breadth situation juxtaposed against the close proximity of the major averages to their all-time highs.

Again, this type of negative breadth divergence has been a bad harbinger of things to come, eventually, for the market. A look at the forward performance of the S&P 500 following these events gives you an idea why we say this may be the most instructive data point in describing the negative divergence between prices and internals -- and its potential consequences.

Losing Weight: Even The Leaders Are Thinning

Despite this preponderance of evidence pointing to the deterioration of the market's internals, the major averages, as well as a select few sectors, continued to hold near their highs. The reason is that a relatively few (mainly mega-cap) stocks kept those areas propped up with their substantial weighting in the indices. However, as the relatively few strong areas of the market began to weaken, there was precious little support left to prevent a significant correction. We recently detailed such signs of deterioration even among the stronger areas of the market.

Equal-Weight S&P 500

We pointed out the first example of this on May 28 with respect to the S&P 500. Though the cap-weighted index was coming off a recent 52-week high, the equal-weight index was beginning to lag. As the name implies, this index applies an equal weighting to each of its components. This provides a more accurate look at the health of the broad market segment than does a cap-weighted index which can mask internal weakness if the largest stocks are still performing well.

This has been precisely the situation beginning with the equal-weight S&P 500 index failing to confirm the cap-weighted index's new high in May. Additionally, after attempting a relative breakout versus the cap-weighted index earlier in the year, the equal-weight S&P 500 broke down below its post-2012 uptrend, recently hitting a 2-year low.

Equal-Weight Nasdaq 100

The technology-heavy Nasdaq 100 (NDX) has been one of the stalwarts of this bull market, hitting a 52-week high as recently as a month ago. However, the equal-weight NDX has also noticeably thinned out, as we indicated on July 22. As with the equal-weight S&P 500, the equal-weight NDX failed to confirm the cap-weighted index's new high in July and has broken down below its post-2012 uptrend to a 2-year low.

Equal-Weight Consumer Discretionary

Lastly, even the leading sectors of the market have been showing weakening internals. One example is the consumer discretionary sector, which was at an all-time high as recently as 2 weeks ago. However, looking at the sector on an equal-weight basis, one can see that the strength was due to some of the larger-cap names in the sector. On a broad, equal-weight basis, the sector has been losing steam over the past few months. Like the examples above, the equal-weight consumer discretionary index failed to confirm the cap-weighted index's recent high and has now fallen to a 6-year low on a relative basis.

July 20: The Turning Point?

Internal deterioration can last for some time before it has an impact on the major averages. However, when the divergences become as pronounced as they have, there is a certain point where they come to a head. Every cycle is different, but, at times, this inflection, climax, turning point, etc. can be narrowed down to a specific day. Such days are characterized by the major averages rising to or near a new high, but accompanied by egregiously poor breadth, relatively speaking. It's as though the market has run out of gas in its push to make one more high. Some examples of such days occurred in August 1987, July 1990. March 2000 and July/October 2007 as well as near various tops in the 1960's-70's.

Obviously, these days are only identifiable in hindsight. However, we did make reference to the possibility that July 20 was one such "turning point day" in a post we titled "The Thinnest New High In Stock Market History". Here is some of the evidence we used to back up that claim.

NYSE

On July 20, the S&P 500 rose to within 0.12% of its 52-week high. Since 1965, there had been 1,564 days on which the index closed higher to within 0.5% of its 52-week high. Among those days:

July 20 had the lowest % of NYSE Advancing Issues (31.7%) of all near-highs on the S&P 500

July 20 had the lowest % of NYSE Advancing Volume (28%) of all near-highs on the S&P 500

July 20 had the 2nd fewest NYSE New Highs vs. New Lows (35%) of all near-highs on the S&P 500

Nasdaq

On July 20, the Nasdaq Composite closed at a 52-week high for the 749th time since 1988. Among those days:

July 20 had the lowest % of Nasdaq Advancing Issues (31.6%) of all Nasdaq new highs

July 20 had the lowest % of Nasdaq Advancing Volume (42%) of all Nasdaq new highs

July 20 was the 2nd time ever with more Nasdaq New Lows than Highs at a Nasdaq new high

To reiterate, based on the evidence above, we labeled July 20 the thinnest new high in stock market history (at least for as far back as we have data on market internals). Despite the new highs, or near highs, in the major averages, the level of participation among the broad market in attaining this new high was staggeringly and unprecedentedly low. Thus, the foundation underlying the new high was extremely weak, leaving the market exceedingly vulnerable once the relatively few advancers finally succumbed.

Indeed, neither the S&P 500 nor the Nasdaq Composite have exceeded their July 20 close since.

Conclusion

The not-formally written first part (1A?) on the Anatomy Of A Market Top would pertain to "background" conditions in the stock market. These conditions, such as valuation, investor allocations, long-term price versus trend, etc. orient us as to the "big-picture" market environment. Identifying the environment enables us to anticipate the types of large-scale moves that arise out of the given climate -- eventually. Currently, the background conditions are as risk-laden as they come. Together, they form a market environment that has historically given rise to cyclical tops in the stock market. However, these background conditions can last for an extended period, years even, before the expected large-scale move unfolds. The fact that we have written about these elevated background conditions for several years now attests to their potential persistency. Something needs to change within the market's structure to effect a cyclical decline.

The first change often occurs below the surface. In Part 1 here, we explain how the deterioration of the market's internals typically occurs in the lead-up and development of a cyclical market top. Weakening breadth, i.e., advancing versus declining issues, new highs vs. lows, etc., even as the major indices continue to make new highs, is the first sign of tangible trouble in the market. That said, this dynamic too can persist for an extended period. Indeed, such negative divergences have been occurring for as long as 12 months now.

However, eventually these divergences reach a head. And the most egregious cases have historically occurred within close proximity to major, cyclical market tops. The deterioration of the broader market is so great that the resultant foundation of support below the surface of the popular market cap-weighted averages is nearly non-existent. Once the relatively few leaders propping up the market begin to collapse under the weight, the inevitable cyclical decline can commence.

That is when Part 2 of the Anatomy Of A Market Top occurs: the breakdown of prices. This looks to be unfolding as we speak, so stay tuned...

Dana Lyons Partner

The commentary included in this newsletter is provided for informational purposes only. It does not constitute a recommendation to invest in any specific investment product or service. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.

Copyright (C) 2015 J. Lyons Fund Management, Inc.  All rights reserved.

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