Pain Now or Later?

A few weeks ago I had to get a spoonful of medicine into my little girl. It took twenty minutes of negotiation, sips of Gatorade, promises of lollipops, pleading, singing, dancing and outright bribery for each dose – we went through this thrice a day. She’s clearly of the Pain Later school.

Which brings me to our own lack of pain in the broader US stock market so far this year, despite how badly we deserve some. As my director of research, Michael Batnick, pointed out on his blog this weekend, 35 times in a row a 10 percent correction in the Russell 2000 has led to a coincident correction in the S&P 500. This is the first time the large caps have been able to stay up despite a small cap sell-off in over a decade.

The question is “Now what?” Shall we get it over it with and have a broad market correction? Or do we “escape” yet again?

Here’s my friend Ari Wald at Oppenheimer with two likely scenarios:

In our view, a seasonal bull market correction has become a question of when, not if. Our top concern is that internal breadth is narrowing. We believe whether weakness in the S&P 500 develops now or later depends heavily on the Russell 2000. We see two possible scenarios developing:

Correction Now Scenario: The Russell 2000 fails to hold support and the S&P 500 consequently follows the Russell 2000 lower.

Correction Later Scenario: The Russell 2000 bounces from support and incites another bout of S&P 500 strength, a more glaring multi-month divergence forms, and a deeper correction ultimately ensues.

We believe that a correction would be healthy for the bull cycle, and that any volatility in the coming months would be a buying opportunity.

Ari’s chart below points out the glaring divergence between the drop in New Highs minus New Lows on the NYSE while S&P 500 price hangs in there near all-time highs. Screen Shot 2014-05-12 at 6.16.43 AM

 

His  conclusion is that the internals are weak and we could use a washout to set us up for longer-term bullish action. A big bounce likely only makes the pain worse later on. With the Russell 2000 sitting on top of meaningful support, we shall see very soon which way this breaks…

Source:

Ari Wald, CMT
Inflection Points – Oppenheimer Asset Management

Read Also:

The Small Cap Divergence (The Irrelevant Investor)

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