There Are Signs of a Pullback on the Horizon

 | Oct 06, 2017 | 6:00 AM EDT
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Stock quotes in this article:

IWM

,

QQQ

Since the calendar turned to October, the big-caps have outperformed the small-caps. I have shown this chart a few times recently noting the red resistance line, but it wasn't until Thursday that the ratio of the Russell 2000 ETF (IWM) to the Nasdaq-100 ETF (QQQ) turned down enough to see it on the chart.

It's certainly the biggest change in that chart since late August when the small-caps went on their rampage of outperformance. While I am still of the mind that after such a pullback in the ratio we'll see another move up, I would note that when the small-caps start underperforming, we get some pullback in some of the indicators.

Before we get to that, the VIX fell hard on Thursday, and yet when we look at the VIX and how it responded at those two prior peaks on the chart above, we discover that there was a pickup in volatility. In May it took three weeks -- which would feel like an eternity in the markets -- and in late June it came and went within a week. But we did not see a continued grind lower in the VIX for much longer.

When I say some of the indicators have seen a pullback, I mean we have seen the number of stocks making new highs contract in the last two days. Not by much, but for example on Tuesday when Nasdaq was 50-plus points lower, we had 367 new highs, and Thursday we had 298 new highs. The NYSE readings are similar.

Thus far, the number of stocks making new lows has not expanded, so it looks like a standard pullback from overbought readings to me. After all, no one has mentioned it, but the transports are down 100 points since yesterday morning when they finally tagged 10,000. I don't think it's a big deal because they should pull back -- that's what markets do -- but that's one reason for the lack of new highs.

The uptrend line for the transports is quite steep, but it hasn't even come close to being violated, which is why this looks like a standard pullback to me right now.

In terms of sentiment, we still have the Fear and Greed Index at 95, which is truly extreme. And the Daily Sentiment Index (DSI) for the S&P 500 is at 89. Again, this is extreme as well. If we look at the 10-day moving average of the put/call ratio, we can see that when it gets down into this area and turns back up, we have seen a correction of sorts in the market. Perhaps the employment number will get it to that extreme level.

But breadth continues strong. Banks continue to do well. The semis lagged a bit this week but they haven't rolled over yet. And the transports look like a standard pullback to me.

For more market analysis from Helene Meisler, sign up for Top Stocks, published five times a week.

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