The stock market added to its post-fiscal cliff gains once again today. Clearly, stocks are no longer reacting to Congress saving us from the cliff. So what’s driving the market higher? It’s a worthwhile process to try to answer this question because all markets are related to each other in one way or another. For this reason I like to not only look at the individual performance of the indexes but also how they compare to each other. It’s sometimes enlightening to discover which indexes are performing better or worse, which are confirming or diverging from each other and to take a look at the market internals all in an attempt to gauge the overall health of a current trend.

Lately, stocks have been led by the small caps (the stocks of relatively smaller companies), financials, transports and home builders. This, in itself, is bullish. Why is that? Well, we are a finance-based economy these days so it pays to pay attention to that sector just for this reason. These sectors are also some of the most volatile, vibrant and vigorous parts of the economy so when they perform well in the markets we can assume (sometimes not very safely, however) that there are solid fundamental underpinnings for strength in stocks generally. Conversely, when healthcare, consumer staples and income-oriented sectors are leading we can’t quite make the same assumption. So just taking a look at the market’s leadership can tell us something.

Some of these sectors have even set significant milestones recently that further buoys the bull case for stocks. Way back in the Fall of 2008 Lehman Brothers went belly up and the financial sector nearly took down all the world’s economies sending back to the stone age, or they would like us to believe. Around this time the Philadelphia Bank Index broke below 50 sending us into the throes of the financial crisis. It didn’t see this level again until the Spring of 2010. Since then the index has gone sideways for nearly three years while the broader stock market has continued to climb. On the last trading day of 2012, however, the index managed to break convincingly back above this level once again. And in the process it also broke out of a long-term pennant formation. These developments bode well for the sector going forward.

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The Russell 2000, the small cap index, also set an important milestone of its own recently by reaching a new, all-time high. While the S&P 500 and Nasdaq remain below the high they set all the way back in 2000, the Russell trades about 50% above its high from that period. The new recent high is even more impressive considering that the index had been trying to break the 868.50 level for nearly two years. The break of the ascending triangle on the chart below is another bullish indication for the index as it is typically a “continuation pattern.”

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The Dow Jones Transportation Average has also set a new, all-time high. The Dow Theory, most famously espoused by Richard Russell, pins its stock market analysis on the relative performance of the Dow Jones Industrial Index and the Dow Jones Transportation Index. If transportation is the lifeblood of the economy than the index is the lifeblood of the stock market. And it’s pumping like Lance Armstrong’s cheating blood beater during an Alps stage of the Tour de France.

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One chink the stock market’s armor is the Nasdaq. The Nas is typically one of the more dynamic areas of the market and it’s underperformance is worrisome to me. Not only is it still a good 5% below it’s recent highs it looks to be forming a pretty clear head and shoulders top pattern. We can attribute a good deal, if not all, of the index’s relative weakness to Apple. It accounts for more than 10% of the index these days. In fact, without the stock the index may very well be making new highs like these others. Still, it’s not a profitable practice to rationalize these kinds of things. It remains that the Nasdaq is lagging and possibly putting in a major top.

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The overall picture is never crystal clear. This kind of analysis requires weighing all the different inputs and then forming an appropriate conclusion. Right now most of the technical signs point higher with the Nasdaq poking a finger in the eye of that conclusion. We’ll keep watching for now. In another post, I’d like to run through this same process for analyzing sentiment data and another for analyzing the fundamentals. This is just one of the tools I use to assess the overall stock market and it’s not nearly as useful as when it is combined with these other two.

Hit the Links

  • The Best Advice From The World’s Greatest Investors (Business Insider)
  • The central bank money-printing party: ‘the only reason gold doesn’t go berserk is people are oblivious’ (Fleckenstein)
  • How We Know That Retail Investors Are Beginning To Freak Out About Apple (Business Insider)
  • Home Prices Climbed 7.4% In November, The Fastest Rate Since May 2006 (Business Insider)
  • DOH! Facebook loses 1.4 million active users in U.S. (Marketwatch)
  • This should be able to bring the cost of going to college way down (NY Times)
  • The Best Wave of Shane Dorian’s Life (Surfer)