Chart Advisor: Evaluating the Bullish Thesis

By Adam Koos, CFP, CMT

1/ The Inverse Traffic Light

2/ Three Ways to Analyze

3/ Looking at the NASDAQ-100

4/ Mega-Caps vs. Micro-Caps

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1/ The Inverse Traffic Light

First, let’s take a look at the stock market with what I call an “Inverse Traffic Light” chart of the S&P 500. 

Today, we sit at the top-end of the caution-zone, which is marked by the early-2022 highs, as well as the July 2023 highs.  If the market were to break north of this potential level of overhead resistance, it would only have the late-2021 all-time-highs to contend with.

On the other hand, if it were to fall below the October low, all bets are off and it would probably make a lot of sense to be nimble, un-marry yourself from the bullish thesis, and get defensive.

Now would probably be a good time to share that, oftentimes, the simpler, the better.  Analyzing the market (or any chart, for that matter) with eight different trendlines, 10 levels of support and resistance, combined with another six “lower” indicators might look cool (I say “messy”), but it doesn’t do a whole lot for a trader in terms of taking action!

2/ Three Ways to Analyze

Case in point, there are three major ways of analyzing the S&P 500 without turning a traffic light upside-down…

First, we can observe the market and two major, well-known moving averages.  In the chart above, we can observe the fact that the market is trading above its 50 and 200-day moving averages (MA), and at the same time, the intermediate-term, 50 MA is sloping up, all while the longer-term 200 MA is also sloping up.

The second way of determining whether we’re in an intermediate-term uptrend would be to simply observe the major lows and highs over the last 12 months.

It hasn’t been pretty, but the market never goes up and to the right in a straight line!  However, if you simply observe the higher-lows (marked with the blue dashed, horizontal lines), you’ll see that all of the major lows have been higher, indicating that we are unequivocally in an uptrend.

Some might consider the lower-lows (see the red dashed lines) from August thru October contradictory to uptrend claim, above.  However, I would consider those lower-lows to be part of a counter-trend within the larger, uptrend. 

This is where everyone needs to know their timeframe.  I personally analyze the markets via an intermediate-term timeframe, so unless the last low (printed in October) were to have remained trapped below the 200MA and/or if the market were to have printed another lower-low and lower-high thereafter, the intermediate-term trend remains intact.

3/ Looking at the NASDAQ-100

Unlike the S&P 500, which is still contending with its summer ’23 highs, the NASDAQ-100 has already broken out above those same levels. 

Furthermore, if you look back to the July to October market correction, momentum (in the lower pane) was unable to break below the bearish level of 30, and has already crossed, once again, above the bullish level of 70 on the breakout.

4/ Mega-Caps vs. Micro-Caps

All that being said, in order to see this market truly get some legs, we’re going to need to see more stocks joining the party and participating in the uptrend.

To elaborate, since the S&P 500 and NASDAQ are cap-weighted indices, when the biggest stocks have a good day, “the market” has a good day.  Similarly speaking, when the biggest stocks have a BAD day, “the market” has a bad day. 

So, when analyzing mega-cap stocks vs. the small and micro-caps, try to remember the analogy that the big company stocks are like the “Generals” on the battlefield, while the small and micro-caps are the “Troops.”  There are a LOT more Troops than there are Generals, and when the Generals run into battle, the last thing they need is to turn around and see the smaller-cap Troops hunkered down in the forest!

Case-in-point, the Russell 2000 represents small-cap stocks in the U.S., which have been poisonous, at best.  Said another way, you don’t even need an RS chart to compare the IWM chart above to the S&P500 or the NASDAQ-100.

In order for the market to continue its uptrend and print new, all-time highs, it would help tremendously to see “the troops” charging onto the battlefield. 

However, patience is going to be required as we move into the month of December, which is typically a time for heavy tax-loss harvesting… which is when weak/laggard stocks are sold at the end of the year to wipe out realized gains taken on winning stocks from earlier in the year.

When tax-loss harvesting occurs, it’ll likely be these beaten down small-caps that take the brunt of the selling this year, which will likely push prices back down toward the lows observed in June ’22, September ’22, and October ’23 (see the bottom of the rectangle annotated in the chart above). 

Once we get past the meat of December and into the New Year, it wouldn’t surprise me to see some buyers step in to the small and micro-caps, in anticipation of a “catch-up” kind of environment into the 1st quarter of 2024.

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Originally posted 27th November 2023