The traditional view of the stock market is that stocks, as a group, tend to move in the same general direction. Therefore, the indices are a good way to determine if there is a bull market, bear market or a correction.
Back in February 2020, when the COVID pandemic hit, stocks all sold off in tandem and there was clear bear market action. The indices told the story quite well.
In 2021, the indices have done a very poor job of summarizing overall market action. Despite the steady strength in the indices, there has been a series of rolling corrections, and many stocks are totally disconnected from the movement in the indices.
The easiest way to see this phenomenon is to look at how extended the S&P 500 is over its 50- and 200-day simple moving averages (SMAs), which would seem to suggest that the great bulk of stocks are also extended. However, the reality is that 40% of stocks are under their 200-day SMAs and sectors such as biotechnology and growth stocks topped in February and have been in a downtrend since then.
On Tuesday, the disconnect between the indices and the broader market was even more extreme. Big-cap technology names jumped higher and pushed the indices to new all-time highs, but under the surface, only 1,600 stocks were higher while 6,300 had declined by the end of the day.
The indices send the message of a roaring bull market, but the majority of stocks are struggling like it's a bear market.
This disconnect makes for very tough trading. Bears who short the indices have little success, and bulls who focus on picking stocks are frustrated unless they focus on a small handful of FATMAAN names.
In a typical bear market like we had last year, stocks trend down together with the indices and the sentiment becomes increasingly negative, which leads to a tradable low. In the current environment, the strength in the indices messes up sentiment. If you just look at the indices, there is an impression of frothy bullishness. At the same time, many stocks are struggling with miserable bear market action. It is tough for a good low to form when there is such a severe correction.
On top of this inconsistency and intense rotation, there is the additional issue of inflation and concerns about the level of economic growth. Prices paid by consumers in June surged by their highest level since 2008 and the Consumer Price Index was well above all estimates. This situation tends to help the big-caps that are viewed as less impacted by higher rates and causes an even bigger market disconnect.
There is little to do but to stay patient and watch how the market resolves these extreme divergences. There is no clear path for resolution, and the disconnect between big-caps and the rest of the market looks to become even more severe before it becomes better.
The indices are looking at some minor strength here before Wednesday's open and the Nasdaq is leading the way on upbeat comments about Apple (AAPL) .