Here’s What Lurks Under a Tranquil Market…

The pain has finally ended.

The market correction has run its course. After days of suffering, stocks are back on track, the experts at Morgan Stanley assure us. We’re ready for smooth sailing once again thanks to a small uptick in the S&P 500’s relative strength index. A little positive divergence is all we needed to get the major averages back on track and headed for new all-time highs.

Thank the market gods! Enduring a 2% “correction” in the S&P 500 was too brutal for most investors to bear…

Never mind that we’re enjoying one of the most tranquil markets in history. The S&P 500 hasn’t posted a 5% pullback in more than a year and investors are sweating a measly dip. Thanks to yesterday’s broad rally, the S&P 500 is now just a little more than 1% from new all-time closing highs. If we do get an actual correction sometime soon, I guarantee investors will completely lose their minds.

Despite everyone getting bulled up again after one strong comeback day, we remain smack in the middle of one of the most volatile time of year for stocks. That’s why it’s so important to dig below the performance of the major averages to get a better feel for what’s going on.

Simply put, the Dow and S&P 500 aren’t always going to tell us the whole story. Just because the overall market’s up doesn’t mean every stock will be up. Likewise, not every stock will be down when the market’s down.

We trade in a market of stocks—not a stock market. While investors, analysts, and the financial media continue to obsess over the major averages, we need to remain selective with our trades.

Why?

Because the big indices aren’t revealing market weakness that’s occurring right now, James DePorre notes over at The Street. James instead points to the Value Line Geometric Index, which is not price-weighted like the S&P 500.

“It basically measures the action in the median stock in the market,” he notes. “This index is now down for the year, trading close to where it was at the end of last November. To put it in simple terms, the average stock is down for the year, although the three major indices are still up substantially.”

As the Value Line index reveals, many stocks abruptly hit the skids this month. Until yesterday’s bounce, the Value Line was solidly in the red for the year. Clearly, sellers have done some damage to the markets over the past couple of weeks.

Right now, the market is showing you one thing on the surface, but another thing altogether underneath, invisible to most investors. That’s why it’s so important to duck beneath the waves to get the truth about what’s driving the stocks right now.

So far this year, the mega-cap FAANGs and other big tech names have performed most of the market’s heavy lifting. Meanwhile, your average stock is sitting on its butt, just going along for the ride. You can’t just throw a dart at a list of S&P components and expect to hit a winner. Not in this market…

We highlighted this market weakness in small-cap and transportation stocks on Monday. While the small-cap Russell 2000 and the Dow Jones Transportation Average participated in yesterday’s rally, both remain below their respective 200-day moving averages and vulnerable to additional weakness. There is still damage that needs to be repaired before we can expect stocks to rip higher.

Frankly, we should welcome any downside action that comes our way this month. Not only would a quick drop shake out the weak hands. It also has the potential to reveal more profitable trade setups heading into a potential year-end rally.

Sincerely,

Greg Guenthner
for The Daily Reckoning

The Daily Reckoning