The Need To Lead?

JC Parets
March 31, 2019

From the desk of Tom Bruni @BruniCharting

One of the topics I spoke about during my Chart Summit presentation on breadth last month was the relative performance of Equally-Weighted versus Cap-Weighted Indexes.

I always hear that the market cannot go higher on an absolute basis if the Equally-Weighted S&P 500 is underperforming the Cap-Weighted.

So is that the case? Let's take a look.

Here's a regression chart of the Equally-Weighted S&P vs Cap-Weighted S&P 500 ratio and the S&P 500.

Click on chart to enlarge view.

Essentially what this chart going back to 2003 shows us is that there's no relationship between the Equally-Weighted S&P outperforming and the S&P 500's direction on an absolute basis. No direct relationship.

Here's a chart of each S&P 500 sector's performance since '09 lows. The difference here is that we're looking at the performance of each sectors' Equally-Weighted Index versus its Cap-Weighted Index.

As we can see, the worst performer has been Consumer Discretionary and the best has been Basic Materials.

Broad-based participation to the upside in Basic Materials must mean that it was among the best performers on an absolute basis, right?

Well, not exactly. Its performance ranks six out of nine, and number one is actually Consumer Discretionary which has the weakest relative performance on an Equally-Weighted basis.

We live in a market-cap weighted world, so over the long-term we can expect the largest stocks to account for the majority of the market's gains. That doesn't mean that breadth analysis can't be a great piece of evidence, but each tool has its own purpose and timeframes on which it works best.

In the case of Equally-Weighted Indexes, they can be helpful over the short and intermediate-term for market timing...but they are a supplement to price and divergences need to be confirmed before we can act on them.

When the Equally-Weighted Indexes are outperforming, it's a signal to us that there may be opportunities in individual components that are not visible at the Cap-Weighted Index level. When they're undeperforming it's the same, but on the short side.

To us, that's what makes this information valuable. Not using it as our primary market-timing tool.

Let us know what your thoughts are.

And if you enjoyed this and want access to all our premium content, start you 30-day risk-free trial or sign up for our "Free Chart of the Week" to receive more free research like this.

Allstarcharts Team

Filed Under