S&P 100 Index (OEX.I) vs Russell 2000 Index (RLS.I) & British Pound / United States Dollar (GBPUSD)

Reaching the middle of the year and a US holiday today gives investors a chance to reflect on the current state of the market. 2024 has gotten off to a very strong start, but there are signs of exhaustion out there and the potential for increased volatility in the second half of the year.

While major indices like the S&P 500 and the NASDAQ continue to trade at or near all-time highs, upward momentum has slowed. The Dow Jones Industrial Average touched 40,000 a few weeks ago and has been dropping back, as have the Dow Transports. Meanwhile, small cap indices like the Russell 2000 have underperformed, indicating the troops are no longer following the generals, and a significant gap in performance has emerged between market cap weighted and equal weighted indices indicating that recent gains have been concentrated in a small number of large cap stocks.

In other words while the top of the tower continues to reach new heights, it seems to be crumbling at the base. May and June were stronger seasonally than average and in a few weeks we move into the seasonally weakest and most volatile time of the year for equities which runs between mid-August and mid-October.

The potentially most significant change in recent weeks has been on the political side. Incumbent parties lost in European Parliamentary elections, lost the first round of French parliamentary elections and there was a Canadian by-election upset. The UK election is today with the incumbent Conservatives widely projected to be facing a major defeat and the second round of French voting is on Sunday.

In the US, meanwhile, election uncertainty has ramped up following last week’s debate and Supreme Court decisions related to the power of government agencies and Presidential immunity have added to the mix. This month, the Republicans hold their convention and meanwhile it’s unclear whether President Biden will continue his re-election campaign, and if he does now, who may replace him?

Amid swirling signs of Stagflation, the economic calendar is busy this week wrapping up tomorrow with US nonfarm payrolls, Canada jobs, and wage inflation. Next week starts off quiet but picks up later with US consumer prices due next Thursday and earnings season kicking off next Friday led be results from several big banks.

In this edition of Equity Leaders Weekly, we look at the growing gap between US large cap and small cap stocks and at the potential impact of today’s UK election on sentiment toward the island nation.

One measure of market breadth for determining the health of a trend is looking at large cap versus small cap stocks. While large caps tend to broadly lead market trends it is important for a wide range of stocks to be participating to confirm the conviction of a trend.

A divergence between large and small caps can suggest that moves in market cap weighted indices are becoming overly concentrated in a small number of names and that changes are occurring under the surface.

When comparing the mega cap S&P 100 Index (OEX.I) versus the small cap Russell 2000 Index (RLS.I), one can see that there performance was similar in the Sept-Oct 2023 market downswing and the Nov-Dec 2023 market rebound. Since the beginning of this year, mega caps have continued to race ahead, but small caps have advanced at a slower pace, indicating the troops have not really been following the generals. More concerning is that since the middle of May, RLS.I has turned downward outright while OEX.I has soared to new highs, suggesting that the broad market rally may be nearing exhaustion.

This 10-year chart of the British Pound versus the US Dollar, commonly known as “Cable”, appears close to a potentially significant technical inflection point which may be influenced by today’s Parliamentary election results. Within a long-term downtrend that played out between 2014 and 2022, one of the biggest drops was in the wake of the Brexit vote back in 2016 (circled)

Cable bottomed out nearly two years ago and since then, it has been slowly but steadily recovering, establishing a new uptrend of higher lows. More recently a Symmetrical Consolidation Triangle has been forming. Depending on the election results we could see a breakout from the triangle. Note like the Yen/Nikkei relationship, a big move by Cable could trigger a move by the FTSE in the opposite direction as the FTSE is made up of a lot of big multinationals, particularly miners and energy companies.

A close above $1.2806 would signal the start of an advance with next potential resistance near $1.3195 and then $1.3460. A close below $1.2185 would signal the start of a new downswing with next potential support near $1.2065 then $1.1710.