Short-term Outlook (1-5 Days):  Neutral  From May 25, 1049 SPX

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Equity Indicators - Updates and Extremes

S&P 500 vs. Nasdaq 100 vs. Russell 2000

The textbooks say that when indexes like the tech-heavy Nasdaq 100 (NDX) and small-cap Russell 2000 (RUT) lead the broader market, then the outlook for stocks in general is bright.  When they lag, then we better watch out.

If true, then yesterday is a bad omen.  The S&P 500 closed higher by more than +1%, yet both the NDX and RUT closed down on the day.

Since 1985, we've seen this occurrence only four times:

03/23/87 - The S&P chopped around for three days, then collapsed.

10/20/87 - The S&P jumped +9% the next day, then sank immediately after.

03/15/00 - The S&P jumped nearly +5% the next day, and +10% over the next week, then sunk.

07/02/01 - The S&P rolled over immediately, losing more than -5% over the next week.

The results were somewhat mixed, at least in the short-term.  Twice the broader market took off, and twice it didn't.  Longer-term, it didn't bode all that well.

Let's take the divergences individually and see if there's anything to it.  First, let's see how the S&P fared going forward when it rallied at least 1% on the day and the Nasdaq 100 declined.  Since 1985, there were 22 occurrences.

Nothing too special here.  Stocked tended to bounce immediately, then sink in the days after that, then rebound more in line with any other random time.

Now let's check for times when the S&P rallied but the Russell 2000 declined on the day.  Since 1979, there were 29 occurrences.

Short-term, the market held up better after these divergences.  In fact, across all time frames the S&P did well, both in absolute terms and compared to any random time.

The takeaway from this is quite different from what the textbooks would suggest.  These one-day divergences have actually been more positive than anything, at least in the short-term.  Taken individually, the market has done OK going forward.  The four times we've seen both the NDX and RUT drop, it was much less kind when looking out several weeks (though it's hard to rely on just four occurrences).

Public Opinion - US Dollar

Sentiment on the US Dollar has continued to become more optimistic as many of its trading partners have suffered.

One measure of that sentiment is our Public Opinion, which shot up to 79.2% this week.  That is the 2nd-highest reading since data began in 1999.  The only other higher reading was 79.5% on November 19, 2008 (the Dollar dropped about 8% over the next few weeks).

The chart below shows the index, with arrows highlighting extremes above 70%.

When Public Opinion crossed from below 70% to above 70%, the Dollar tended to struggle going forward, as the table below shows:

During the next three months, the Dollar's average maximum gain was +1.5%, while the average maximum loss was -5.6%, so a huge difference between risk and reward there - it just wasn't often able to maintain additional short-term upside.

Other data, like speculator positions and Rydex fund flows, aren't necessarily confirming the excessive optimism readings, but the results from the table above are consistent enough that more weakness than strength seems likely in the Dollar.

Let's compare Dollar sentiment against the S&P 500 since the panic began in 2008, since the correlation between the Dollar and S&P has been negative much of that time.

For the most part, when sentiment on the Dollar was extremely low (the red highlights), the S&P was about to to out, at least in the short-term, as the Dollar most often rallied.

When sentiment was overly optimistic on the Dollar (green highlights), the S&P was going through three major bottoming periods during November 2008, March 2009 and February 2010.  Whether it's occurring again now we'll just have to wait and see, as it depends on if the correlation is going to continue or not.

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