Tracking Technology versus the S&P 500
The equity market is driven by flows of funds from one sector to another for a number of reasons including large money managers directing funds based on their fundamental outlook for the economy. It follows that if the economy is showing signs of growth then money should be flowing into equities that will participate in the economic expansion, such as technology. If the economy appears to be slowing, then funds will be directed by equity managers into defensive stocks, which are those companies that pay dividends and offer services that consumers will be using despite the slowing economy. One way I track this is to follow the NASDAQ 100/S&P 500 ratio. CQG users can type in NDC5/SPC5.
We’ll use a weekly review just to highlight the main points. Traders interested in a detailed analysis can find an article I wrote for Active Trader magazine at this link: http://store.activetradermag.com/index.asp?PageAction=VIEWCATS&Category=240
The article is called The Telltale Spread and appeared in the November 2003 issue.
The first example starts with the market bottom back in 2002-2003. The S&P 500 formed a bottom over the course of more than six months. However, the ratio bottomed in September 2002 and was rallying during the period the S&P 500 was making the bottom.
Jumping to early 2004, the ratio peaked in January while the S&P 500 climbed for another two months, and then followed the ratio down.
The ratio peaked in the 4th quarter of 2004 while the S&P advanced into March of 2005, and then broke down.
The ratio peaked in March of 2006 and the S&P 500 peaked in May. However, the S&P 500 bottomed in June and the ratio did not turn up until August. Since August, the ratio has been confirming the advance buy the equity markets.
What these charts illustrate is there can be considerable time between the ratio changing direction and the broad market moving with it. However, thinking of the ratio as one of a number of key indicators can be helpful towards being prepared for a change in the trend by the broad market.
The ratio can be tracked on a daily basis or an intraday basis. Use your favorite studies to classify the ratio as in an up trend or a down trend. I use the 14-bar RSI. If I see readings in the RSI of the ratio over 62, then the momentum is positive. If the RSI is flashing readings between 62 and 38, then the ratio is in a trading range. Finally, if the RSI readings are coming in below 38, then the ratio is in a down trend.