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Are the divergences between SPX and RSP not sustainable?

The SPX market-weight ETF (SPY) and the SPX equal-weight ETF (RSP) track the same index (SPX). Although both consist of the same SPX companies, they can trade differently.

The difference between SPY and RSP is the former is influenced heavily by the most significant market cap components (i.e., mega-cap S&P 500 technology names). While the latter are equal in weight and have a similar impact.


As the name implies, every stock in an equal-weighted ETF has the same weight, regardless of the size. The most influential component of the SPX by market cap (APPL) has the same weight as the smallest.


Since mid-size and smaller S&P 500 companies have the same influence on the index as larger-cap companies, it creates a more equitable, balanced, and diversified portfolio.


The equal-weight index can reduce concentration risks by spreading the risks evenly across the index, allowing investors to have representation of a wide selection of businesses in numerous sectors and industries.


An equal-weight index can offer investors more protection if a large sector (i.e., technology) suffers a significant downturn, as the smaller sectors underperforming can offset losses more than they would from a market-weight basket. However, if a sizeable market-cap weight sector performs exceedingly well, the equal-weight index can also dramatically outperform the market-weight index.

An equal-weight index can also be another way to measure the internal health of the underlying index (SPX) or market breadth. Not favoring larger-cap companies offers a better and more accurate picture of the entire market.


Just because equal and market cap SPX ETFs hold the same names in the basket does not mean they will perform similarly.


Equal-weight indexes can easily underperform or outperform market-weight indexes due to market conditions and the performances of the largest sectors and mega-cap stocks.


During devastating bear market declines, investors tend to favor the safety of larger-cap names. An equal-weight index with large concentrations of smaller-cap and illiquid companies may be vulnerable to higher volatility during a sharp market selloff.


Equal-weight indexes are popular for investors who seek broader diversification and less concentrated positions. Although equal-weight indexes have historically outperformed market-weight indexes over the long term, they tend to be more volatile, especially during bear markets.


Most of the time, the equal-weight RSP and the market-cap weight SPX and SPY will trade together, trending up or down in the same direction. However, during adverse market conditions or market inflection points, the divergences between the two markets can signal an impending trend change.


A brief review of the RSP and SPX shows divergences between the two ETFs.

RSP has violated the 200-day ma (145.09) and the Oct 2022 primary uptrend (146), implying the mega-cap Technology names are much weaker than the other SPX names into the Jul 2023 to decline.


Also, the 4-month triangle breakdown below 146 warns of a decline of 11.20 points toward an RSP target of 134.80. The next RSP support is the May 2023 lows (137.61), the extension of the Jan 2022 downtrend breakout (137.75), and the Nov 2022 uptrend (138.5). Below 137.61-137.75 signals a deeper correction toward 134.62-136.14, which coincides with the Dec 2022 and Mar 2023 reaction lows.

The market-cap SPX Index is currently testing the Oct 2022 uptrend (4,275) and is trading comfortably above the 200-day ma (4,194.5) and May 2023 breakout (4,195.44). Violation of 4,396 (9/20/23) or the bottom of the 4-month triangle pattern suggests 260 points or an SPX decline toward 4,136. The 4-month head/shoulders top neckline breakdown below 4,328-4,335 (6/26 and 8/18/23 lows) suggests downside risks to 4,056 or near the Apr/May 2023 lows (4,048-4,049).

The divergence between the two indexes and wide discrepancies are not sustainable. A reversal in the equal weight (RSP) or the narrowing of the spreads between the two markets can be a constructive development, possibly leading to the end of the Jul 2023 consolidation and the beginning of a market recovery.


Source: Chart courtesy of StockCharts.com

Source: Chart courtesy of StockCharts.com

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