Rotating tires is a basic maintenance procedure all drivers should perform in order to extend the life of their tires while also maximizing traction to insure safer driving conditions. A stock market rally does the same thing, but instead of tires it rotates sectors. In this way, sectors that have run too much too fast can consolidate while the sectors that have lagged can catch up while the overall trend remains intact. Over the last few weeks of consolidation, it appears that we may be in the process of a major rotation as the tech companies of the Nasdaq take the torch from the small cap names in the Russell 2000 that have led us for several months.
Below you will find charts of the S&P 500 (SPY), the Russell 2000 (IWM) and the Nasdaq composite index (QQQ). Notice the stark difference between this week's action versus April of this year. During the early part of the year, the small caps were making new highs while the S&P 500 and the Nasdaq composite lagged noticeably. In fact, it wasn't until IWM formed a second pivot high in May that the other two indexes were able to finally clear their February highs (QQQ barely doing so after a furious charge).
However, contrast that to the action this week when QQQ broke out convincingly to new highs while the Russell 2000 and S&P 500 remain close to their initial February highs. While this divergence lends credence to the theory that we are now rotating into tech names, it also shows that the market is still in a bit of a mixed state as only one of the major indexes has been able to eclipse the highs we made in May. With many of the major earnings reports in the Nasdaq composite out of the way now, watch for some quieter action in QQQ over the coming weeks as it begins to realign itself with its peers. Keep an eye on the interplay between these three indexes in the coming weeks as they will give us significant clues as to where the money is flowing as we continue to come to terms with this broad range of consolidation we have been trapped in for most of 2011.
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