Last week was our Members-Only Conference Call, where we discussed what we’re seeing in Equities, Commodities, and Currencies. During our discussion around Equities there were two themes that came up over and over again due to their impact on the overall market’s direction: weakness in the Financial Services sector and small-cap under-performance.
Given the mixed signals we continue to get from this market, I wanted to share my thoughts on these themes and get feedback on what you all are seeing out there.
The first chart is the Nifty 500 overlayed with its largest sector, the Nifty Financial Services Index. We originally wrote about this earlier in the month, suggesting that a failed breakout in this sector would likely lead to weakness in the broader market due to its massive size, and that’s exactly what we’re seeing. Unfortunately nobody knows for how long or how far this failed move will propel prices lower, but what we do know is that from a risk management perspective there’s no reason to own the sector nor the broader Nifty 500 if they’re below their respective January highs.
Click on chart to enlarge view.
The other chart to watch is the ratio of the Nifty Free Float Smallcap 100 vs Nifty 100. Small-cap under-performance has been a theme all year and we wrote in July that history suggested this divergence would have to resolve itself by small-caps playing catch-up, or the broader market playing catch-down. Two months later we finally get our answer as the ratio hits nearly 4.5-year lows and the Nifty 500 trades back below its January highs.
The Bottom Line: The major indices extended their losses late last week, with many of them closing at or below our tactical risk management levels on the long side. Despite the sector rotation we’re seeing under the surface, the dominance of large-caps continues to suggest a lack of risk appetite and weakness in the largest sector, Financials, continues to drag the market lower. Until we see stabilization in these two charts, we’re unlikely to see a resumption of the Nifty 500’s structural uptrend.
With that said, there continues to be plenty of opportunity under the surface, many of which we discussed on the conference call. We also acknowledge that the direction of the major averages certainly plays a role in how we approach the market, so the relationships above are two that we want to continue to monitor as we head into the fourth quarter.
Thanks for reading and please let us know what you think!
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