The stock market rallied for the seventh time in eight days yesterday, but Monday’s move was a very narrow one, and it came on very low volume. Despite the 20-point rally in the S&P 500, the breadth for that index was actually negative. In fact, it was negative for the Nasdaq Composite yesterday as well, even though it rallied almost 1%. The big cap NDX Nasdaq 100 index did have positive breadth of just over 2 to 1 positive, but for an index that rallied 1.12%, that is not good number. So, you can see that not only was the rally concentrated in the mega-cap tech names, but it was concentrated in just a few of those stocks.
We had some interesting developments in other parts of the world overnight. First, ECB Governor Holtzman said that the ECB is thinking about reducing the central bank’s pandemic aid. So, it looks like the Fed is not the only central bank that is looking to become less accommodating. This news has the European markets trading lower this morning and it has caused the domestic futures to rollover and trade in negative territory as well. That said, these moves are not big ones at all. Most of the European stock markets are down less than one half of one percent and the U.S. futures are only down very slightly as we write.
We’ve also heard more negative news out of China. Xi’s government is moving towards extending their reform measures by adding further restrictions to fight monopolies and shore up strategic reserves. On top of this, they have announced a crackdown on private equity funds. In response to these new developments, China’s stock market did fall about 1% midday, but it was able to climb back into positive territory by the close. So maybe we have nothing to worry about. However, those who have a lot of money invested in China certainly have more to worry about today than they did yesterday (and they had plenty to worry about yesterday).
To make matters worse in China, China Evergrande Group warned investors that it risks defaulting on their bonds if their attempts to raise cash falls short. The company themselves said, “Shareholders and potential investors are advised to exercise caution when dealing in the securities of the group.” This was not a warning from regulators, it came from the company itself!!! Of course, this could have been a thinly vailed plea to the government to finally bail them out, but there is no question that this situation is deteriorating significantly. More importantly, given if (God forbid) they were allowed to collapse it could have an important impact on China’s economy given the company’s exposure to so many areas in that country. It could even raise questions about a possible contagion, say some experts.
None of this seems to matter to the U.S. stock market. As we said above, certain mega-cap tech names continue to push higher, so maybe that’s all we need to ignore some of these potential headwinds. However, we’d just finish by highlighting that the NDX Nasdaq 100 Index is now trading at an almost 70% premium to its 200-week moving average. This compares to a premium of “only” 45% at the tops before the last two deep corrections (in late 2018, and early 2020).
We do admit that the premium hit a similar 70% premium in August of last year and in March of this year and those were not followed by deep corrections. However, they were still followed by declines of 12% and 10% respectively! Therefore, there are still reasons to worry about the near-term upside potential of the big-cap tech area of the market. (We’d also note that before the last 12 months, the NDX had never reached a premium of even 50% since 2000.)
“Premiums to moving averages” is not at the top of the list of what most technicians look at when looking at the charts. However, it does show that this part of the market is becoming VERY extended. It does NOT mean that the fundamentals of the mega-cap tech companies are about to turn down. It simply means that the stocks of these companies are getting quite overbought on a technical basis. Therefore, these mega-cap tech stocks are getting ripe for a pullback, EVEN if their fundamental outlooks do not turn down. This will be especially true if we start to see long-term interest rates start to push higher (for whatever reason).
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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