I've been wondering lately if there is really a sea shift in market leadership going on with tech stocks, as reflected in the biggest cap Nasdaq (NDX) index and the big cap S&P 100 (OEX)? (There are a few stocks that are in each index of course.) A slight variation of my wondering is whether NDX has broken out to a big new up 'LEG' and if this index is just going to go its own way like the Dow had done sometimes? It got me wondering about the long-term trend of NDX versus OEX. I used to trade spreads a lot, but I had not looked at NDX versus OEX in awhile.
A ratio chart, or the larger index divided by the smaller, is my preferred way to look at the two indexes versus a spread chart that would subtract the smaller index (in terms of numerical value) from the larger.
But first, I'll revisit where each Index is in terms of 1.) the broad uptrend channels each has been in, looking for whether NDX and OEX are at potential resistance (or has broken out, as would be expected in a new up 'leg') and 2.) how 'overbought' each index might be in terms of the 13-week (quarter of year) Relative Strength Index (RSI).
WEEKLY CHART UPTREND CHANNELS
NASDAQ 100 (NDX):
My first weekly line chart below assumes that today's NDX close is also the weekly close. Today's NDX close is just a hair's breadth from resistance that is implied, but not yet 'proven' to lie, in the 2200 area or at the top end of its major uptrend channel; as highlighted below. To suggest that the Nas 100 Index has achieved a decisive upside penetration of technical resistance would take a close this week above 2200. Stay tuned on that!
Again of course, the week is not over and the weekly RSI ('length' setting equal to 13) will go up, down, or stay the same from the level showing in this indicator today. In the time frame shown above there was an exception in mid-2003 to an RSI in the overbought range coinciding with a big decline that followed. There are almost always exceptions to technical models! Otherwise, we could just follow these things and ALWAYS make money, assuming we didn't overtrade. WRONG!
I didn't mention the period apparent in late-2005/early-2006 per the chart above, when the RSI got to its typical overbought zone but prices shot up another time. Not hugely higher, but we're talking options trading here, not being short a stock! However, during that juncture, in a classic price/RSI bearish divergence, RSI failed to confirm that higher high; after that divergence it was a long way down to a major bottom in mid-2006.
WEEKLY CHART UPTREND CHANNELS
S&P 100 (OEX):
I can't say that it's at all a similar situation, but I haven't seen this pattern of rising weekly closing prices, against the pattern of a DECLINING trend in the 13-week RSI; as highlighted by the down trendline on the RSI chart above. Such divergences can go on for a long-time but they usually, and I'd emphasize 'usually', such divergences end with a steep decline at some point. Stay tuned on that!
THE NDX/OEX SPREAD RATIO:
In some ways, this is the most interesting and telling chart. At the market bottom in October of 2002 (specifically, the week ending 10/4/02), with NDX closing at 815 and the OEX at 403, NDX was 2.02 times the (numerical) value of OEX; this is highlighted at the level line on the lower most ratio line of the chart below. Today's ratio was 3.03!
It's clear that NDX has been gaining on OEX for some time on a PRICE basis. Of course, NDX was started in 2002 from a point that was MUCH lower than OEX in terms of its percent decline from the 2000 top. This doesn't concern us in terms of trading the relative indexes in terms of calls to puts on an equal weighted basis. There have been times that being in the appropriate number of NDX calls relative to OEX puts was a winning strategy.
Moreover, it's apparent that there have been support and resistance areas in the NDX/OEX ratio. The 2.51 level was a support floor to NDX/OEX in mid-2004 and 2.99 was a 'resistance' area in late-2005/early-2006. The dip in the ratio back to near 2.51 in August of 2006 took the spread again back to an area of support; i.e., NDX with better upside potential relative to OEX. Buying NDX calls versus OEX puts turned out to be a winner executed in the right proportions.
Buying pullbacks to the up trendline on the ratio chart in May 2007 (long NDX calls versus OEX puts) was not unlike buying a stock or index on a similar pullback to an up trendline.
At this juncture an interesting question is whether the spread between NDX and OEX has gotten about as wide as it's going to get. The relative valuations have now carried a bit above the high of the NDX/OEX ratio seen previously in the multiyear timeframe shown above, but I would look on this as a sort of natural 'resistance' area rather than a breakout.
The probability of NDX soaring a whole lot further relative to OEX wouldn't be my bet of the year, but we'll see won't we. Analysis of the NDX/OEX spread widening is another way of looking at NDX resistance potentially being close at hand. This, irrespective of rebounding moves in EBAY, GOOG, MSFT, INTC, YHOO and, last but not least, in AAPL.
GOOD TRADING SUCCESS!