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Ominous Indicator or Wrong Interpretation?

The ratio S&P 500/NASDAQ-100 fell recently to 2000 top levels and some think that is an ominous indicator. The other explanation is that the ratio reflects a transformation of U.S. economy and it is far from ominous.

The chart below shows the ratio S&P 500/NASDAQ-100 since 1986.

The ratio fell to 0.29 and this is the level realized before the bear market that started in 2000 and at the top of NASDAQ-100 in March 2000. Is this an ominous indicator that points to a bear market?

Let us ignore for now the fact that this is a sample of one. The indicator reveals the tech sector outperformance as compared to large caps.

In 2000, the indicator fell to 0.29 due to dot com rally and then a bear market began due to dot com bust. The ratio rose to about 1 during the bear market and then reverted again on a downtrend towards the 2000 lows. Does this mean a bear market is about to start?

The traditional technical analysis crowd that looks at lines without considering fundamentals may say this is an ominous indicator. However, fundamentals play an important role in medium to longer-term trends.

It may be the case that the indicator reflects dominance of U.S. large tech cap stocks in a global economy. This trend may continue for several more years or even decades until interrupted due to a change in fundamentals.

The change in fundamentals that could interrupt the current trend is not obvious at this point. It could occur but a quick reversal is unlikely. The current tech market has no relation to dot com tech market and the stocks that are pushing NASDAQ-100 to new highs have solid fundamentals. Possibly, a worsening of the pandemic could affect those stocks too but recent experience is that their position strengthened during the first phases of the virus spread.

The above chart mainly reflects that the broader large cap market lags tech but besides the possibility of the latter falling, there is also the possibility of the former catching up.

We have identified similar indicators months ago and have included them in our weekly premium reports. This is what we wrote in one of those reports:

At some point the trade in those large caps will get very crowded and investors will want to secure profits. This in addition to fundamental factors may trigger a bear market. This is a scenario that can be invalidated if there is a broader market rally at some point.

Samples of one lack forecast significance and due to that they must be evaluated in the context of fundamentals. Quick conclusions based on the technical analysis approach could be misleading, simplistic, or even naive.

Charting and backtesting program: Amibroker

Data provider: Norgate Data

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