Let's talk about small caps. Again. Because that really has been where the action has been, hasn't it?
It's where that tight channel has been. The one that has been in place -- and has worked -- for six weeks now. The key is if it fails to tag the upper line before it turns back down and heads for the lower line. That's generally when the pattern is about to change.
Now let's talk about something else regarding the small caps. Typically, when the Russell 2000 is on a roll, breadth is great. And when the breadth isn't so hot, the Russell tends to struggle, as well. Here is the McClellan Summation Index with the Russell, so you can see how they tend to move in tandem. Directionally, they tend to be consistent with each other.
Yet, two weeks ago, the Summation Index, which smooths breadth out so we reduce the wiggles, stalled. Since then, it has been unable to regain its swagger to the upside. On Tuesday, we saw the Russell gain 1% and we saw breadth negative. That is a very rare occurrence. Sentimentrader even tweeted out a chart of the three times it has happened since 1979.
Small cap stocks drive the breadth figures on the NYSE to a large extent. When small caps do well, breadth is good, and vice-versa. Not today.
Today is one of the few times since 1979 when the Russell was up 0.9% or more and yet NYSE breadth was this negative. pic.twitter.com/wIaDz0hkub
— SentimenTrader (@sentimentrader) December 22, 2020
I can tell you this: It surprised me that it only happened three times. It surprised me even more than you can imagine that it happened twice just before the 2000 highs and twice near the 2007 high.
The Summation Index has clearly rolled over now and the Russell keeps cranking upward. This is a negative divergence.
There were some other data points from this week I'd like to share with you. The put/call ratio was .61 on Tuesday. That is shocking considering the Dow Jones industrial average lost 200 points, the S&P was down 7 and breadth was negative. It is the lowest reading since August 10. Here is a chart of Russell 2000 fund (IWM) with a blue arrow indicating the last time the put/call ratio was so low. I would remind you that just over a week ago the put/call ratio was .97 (high) as folks got concerned heading into a weekend. Now they are seemingly carefree.
The other sentiment data point is that on Monday the put/call ratio for the Volatility Index was the lowest it has been since early September. Starting sometime in mid-September, the put/call ratio for the VIX started to crank upward, with readings over 1.0 on a very regular basis. That's where the red arrow on the chart is. I know this has a tendency to confuse so let me pause and explain.
A one-off low put/call ratio for the VIX tends to be bullish for stocks, because it means too many are betting on a higher VIX -- meaning lower stocks. Conversely, a high put/call ratio for the VIX tends to be bearish for stocks, because too many are betting on a lower VIX (higher stocks). When, however, the put buyers get so aggressive and so persistent as to move the 21-day moving average upward, it gets bullish, because you want to bet with the pros and their persistence.
The 21-day moving average skyrocketed in October, peaking just after the election. While they are not as aggressive as they were, you can see the moving average hasn't even pushed back under 1.0 yet. So why, on a down day like Monday, was the put/call ratio so low for the VIX? Have these pros switched from betting on a lower VIX to a higher one? Time will tell, but that is a subtle shift.
