Is this rally for real? Does it still have legs after the unprecedented recovery? Questions like these are now raised daily by investors and traders.
Stocks seem to have established a significant market low when the S&P 500 index hit an intra-day low of 2,191.86 on 3/23/20 after plummeting 35.41% from its 2/19/20 prior record high of 3,393.52. However, establishing a bottom is only one half of the investment equation. The other half is whether this is a sustainable rally.
The answer to the above question all depends on which stocks and which stock markets are you invested in.
If your portfolio is heavily situated in large-cap Technology and Communication Services stocks and the stay-at-home stocks then you are doing quite well. You would likely be of the view that the market rally still has legs. On the other hand, if you are heavily situated in small-cap stocks, Energy names, and deep value stocks then you are likely to be of the view that this market recovery is only an oversold rally that will soon fade.
From a technical perspective, the structural bull trends or the longer-term trends of the stock market in question will likely override the intermediate-to-shorter-term trends. This will likely decide if the current rally is sustainable or longer-lasting. Another equally important factor is the market internals. The broadness of the stock market rally or internal health is often crucial to the sustainability of the rally. Sustainable longer-term bull rallies are associated with strong market breadth readings. Market breadth highs should accompany new all-time price highs in the underlying index.
Since the Mar 2020 market bottom, the market rally has been mixed with several key indexes performing well while others lagging. It continues to be a market of the haves and the have-nots. One of the primary reasons for the discrepancies in performances between major market indexes is the market-cap weightings of several key sectors. For instance, the SPX Index (SPX) is dominated by the S&P Information Technology (XLK - 28.55% Mkt-cap) and the Communication Services (XLC - 11.13%). For the NDX Index (NDX) over 44% of the index is comprised of the Technology sector and nearly 21% comes from the Communication Services sector. Over 53% of the total market-cap weightings of the NDX Index are the top 10 holdings (MSFT, AAPL, AMZN, FB, GOOGL, GOOG, INTC, NVDA, CSCO, and ADBE).
Based on market internals the recent market rallies have also shown mixed readings. That is not all major market indexes have recorded new all-time highs. For instance, key market indexes such as Dow Jones Industrial Average (INDU), Dow Jones Transportation Average (TRAN), NYSE Composite Index (NYA), S&P 400 Mid Cap Index (MID), and Russell 2000 Index (IWM) are still trading below their respective all-time highs.
Does this then imply the market rally is narrow-based and therefore not sustainable?
Not necessarily. A few large-cap US stock market indexes such as S&P 500 Index (SPX), NASDAQ Composite Index (COMPQ), NASDAQ 100 Index (NDX) have indeed recorded new all-time highs. Interestingly, a sign that the market rally may be broader-based than expected is two of the broadest US stock market indexes of publicly traded US corporations namely, the Wilshire 5000 Total Market Index – WLSH and the Russell 3000 Index – IWV is both trading at new all-time highs.
One final point worth mentioning - the 2-plus year broadening patterns remain intact for many of the key US stock market indexes. A convincing move above these resistances would further reaffirm new all-time highs and the continuation of the structural bull trends.