Daily Brief - ☀️ Two odd market divergences

TLDR: The first rule of observed market patterns? They won’t last, possibly even past the trade you were about to make betting on one. Capital moves around in an economy that changes constantly, abandoning relationships faster than a dating app user. But some departures from the norm are still worth noting. Here are two.

In his excellent blog, John Authers highlights the current divergence between the S&P 500 and an equal-weighted version of itself. Each constituent is given a 0.2% allocation regardless of its size, and then compared to the S&P 500, in which companies are represented in proportion to their market value. When the equal-weighted index is performing better, it’s a sign of a broad market. At the moment, the market is anything but … the equally-weighted index has been doing terribly.

That sounds terrible (if you’re the small stock). But does that tell us much about future market performance?

Actually, very little. There is no incontrovertible evidence that would point to any predictive power from narrowing breadth alone. There is some mixed evidence that large market peaks form on increasingly narrower breadth.

However, they are accompanied by a bunch of other bearish indicators, and develop over a period far longer than the 3-4 months this rally has gone on.

The second divergence worth noting is the performance of bank stocks.

Historically, bank retrenchment inevitably put downward pressure on the whole economy soon after. As Authers points out, this relationship is not just a correlation; weakened banks eventually weaken the entire economic ecosystem.

The survey from the Fed - Senior Loan Officers - showed clearly that lending standards have begun to tighten. Eventually, this proves to be a meaningful drag on profits.

This economic relationship is worth paying attention to. The narrow leadership may be a temporary phenomenon but banks tightening their purses directly restricts the flow of oxygen to the economy. And it can’t function without credit.

Stay tuned.

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