The Average NASDAQ and Russell 2000 Stock is Already In A Bear Market

There are no perfect stock market indexes that'll give you a complete picture of the state of the market.

Most market-watchers prefer the S&P 500 over the Dow Jones Industrial Average. But the fact that the S&P 500 is with striking distance of its all-time high of 1,897 belies the fact that many stocks in the index and in the market as a whole are way down.

"When we examine breadth in terms of new highs, more specifically stocks that are in ‘striking distance’ to a new high, we see a completely different picture," writes J.C. O'Hara, of FBN Securities. "Often at the end of bull markets, large cap stocks continue to rise and the smaller stocks begin to flatter."

The S&P 500 is cap-weighted, which means larger companies like Apple and ExxonMobil have a much larger impact on how the index moves.

"High cap stocks influence the averages more thus can mask internal weakness," continued O'Hara.

O'Hara's research found that the average S&P 1500 stock is down by more than -12% from their recent 52-week highs. The average stocks in the Russell 2000 and Nasdaq Composite are down by more than -20%, which means you can say they are in bear markets.

"Historically, this sort of divergence does not bode well for the longevity of a market’s upward inertia," said O'Hara. "We went back and examined instances where the market made a new high and looked at where the median stock sat compare to its high. Our data suggests that the current breadth reading is very unhealthy. Not only are new highs diminishing but we are seeing many stocks making new lows. This breadth divergence is a major concern."

O'Hara says this isn't necessarily a screaming sell signal.

"However the powerful message of “there is something wrong” should not go unnoticed," he cautions.


Read more: The Average NASDAQ and Russell 2000 Stock is Already In A Bear Market

1st Quarter 2011 Stats: S&P 500, Small Caps, Foreign Stocks, T-Notes

The S&P 500 gained +5.9% in the 1st quarter of 2011.  For all of calendar year 2010, the S&P 500 gained +15.1%.  The S&P 500 has gained an average of +9.7% per year (total return) over the last 50 calendar years (i.e., 1961-2010) (source: BTN Research).    

As of its end of the 1st quarter closing value (1326), the S&P 500 is still -18% below its all-time closing high of 1565 set on 10/09/07. (source: BTN Research).     

The international stock index EAFE gained +3.4% YTD (total return) through 03/31/11 and is up +10.4% on a trailing 1-year basis as of the end of the first quarter this year.  The EAFE stock index has bested the S&P 500 on a total return basis in 7 of the previous 10 calendar years.  The EAFE is an unmanaged index that is generally considered representative of the international stock market (source: BTN Research). 

The small-cap Russell 2000 is up +7.9% YTD (total return) through 03/31/11 and is up +25.8% on a trailing 1-year basis as of that date.  The Russell 2000 index is an unmanaged index of small-cap securities which generally involve greater risks (source: BTN Research).     

The yield on the 10-year Treasury note was 3.46% on 03/31/11.  The yield on the 10-year Treasury note was 8.05% on 03/31/91 or 20 years ago (source: Treasury Department). 

Small-Cap Momentum Bullish for Stock Market

On February 25th, a streak of 9 straight up days in the small-cap Russell 2000 index had just been broken by a relatively large decline.

Far from signaling an end to the momentum, in similar historical circumstances, we nearly always saw that index recover the loss, usually very quickly, and it continued to do well over the next month or so.

It has certainly continued that winning pattern lately, and has now been positive 16 out of the past 18 trading days.

In both the short- and long-term, the small-cap index has, in the past, tended to exhibit a continuation of the momentum, and with strong average returns.


This is often a by-product of a market that is emerging from oversold conditions, and buying interest is so eager that we see extreme momentum. And that is one of the strongest buy signals we can encounter.

Whether our current situation qualifies as having emerged from oversold conditions is debatable - we got quite a few of those indications in February, but the index is already trading at a new high.

Similar historical action suggests perhaps a short-term pause, and questionable prospects over the next several months, but at the very least we'll likely see at least one more new high after whatever short-term correction may come.

On average, under similar historical conditions, , the Russell 2000 has gained +2.9% in three months, +6.1% in six months and +20.0% one year later.

Ominous Divergence Implies Caution

Charts courtesy www.StockCharts.com

The Dow Jones Industrials ($INDU), a proxy for blue chip stocks, closed at a new weekly cycle high (10,318) on Friday, November 20.

The Russell 2000, a proxy for the small-cap sector, posted a weekly close at 585, which was -5.1% below its Friday, October 16, 2009, close at 616.

That's not what we like to see. If blue chips are making new highs and small cap stocks are not, it creates a negative divergence, a non-confirmation that typically signals an end to an intermediate-term rally.

The healthiest stock market rallies occur when all of the major sectors and indices capture new highs in concert. When they don't, it typically signals that stocks will correct and/or begin moving in a sideways range.

And the most profitable and least risky rallies occur when small-cap stocks lead. That's because small-caps are considered the riskiest of the three capitalizations (large-cap, mid-cap and small-cap). And when investors are willing to bid small-cap stocks to new cycle highs, they are confident that the stock market and the economy are healthy enough to support one of the riskiest areas of the stock market. 

Other key sectors that DID NOT confirm the weekly new cycle high on Friday include the bank, brokerage, financial and semiconductor stocks.

Until these sectors and the smallcaps post new cycle highs along with the Dow Jones Industrials, the odds are high that the stock market will undergo a correction.