S&P 500 can indicate when the broad
market is making a genuine move
or when it’s faking people out.
The S&P 500 consists of the 500 largest publicly traded companies measured by market cap. It is designed to reflect the broader market.
TABLE 1 S&P 500 COMPOSITION
Top stocks Top groups
General Electric 3.19% Financials 20.50%
Microsoft Corp. 3.06% Information technology 16.20%
Pfizer, Inc. 3.00% Health care 14.80%
Exxon Mobil Corp. 2.67% Consumer staples 11.70% Wal-Mart Stores 2.62% Consumer discretionary 11.10%
Citigroup Inc. 2.45% Industrials 10.40%
Johnson & Johnson 1.71% Energy 5.80%
American International Group 1.60% Telecom services 3.90%
IBM 1.59% Utilities 3.00%
Intel Corp. 1.51% Materials 2.70%
Exchange (CME). We’ll use the spread between the S&P and Nasdaq 100 futures contracts in this analysis.
We’ll begin by looking at a longer-term use of the Nasdaq-S&P spread before shortening the time horizon and examin- ing ways to identify intraday trend changes.
Finding the market leader:
S&P safe haven vs. Nasdaq growth The S&P 500 is a capitalization-weighted index of companies with market caps (stock price multiplied by number of
shares outstanding) in excess of $3 billion. The larger a company’s market capitalization, the more its stock price affects the index value.
The S&P 500 is designed to reflect the risk and return characteristics of the broader, large-cap market. Table 1 shows the top individual holdings and the group breakdown of the S&P 500.
The Nasdaq 100 is comprised of the 100 largest busi- nesses, excluding financial companies, traded on the Nasdaq stock market exchange. The index uses a “mod- ified capitalization-weighted” approach, by which stocks are weighted with a proprietary algorithm when- ever any stock represents more than 24 percent of the index’s total market value, and/or the combined weight of all stocks with weightings of at least 4.5 percent exceeds 48 percent of the index’s total market value.
Table 2 is a recent list of the top Nasdaq 100 indi- vidual stock holdings and a breakdown of its most heavily represented groups.
The Nasdaq 100 contains a much higher percentage of technology stocks than the S&P. Table 2 shows the computer and office equipment industry group com- prises 28.39 percent of the Nasdaq 100, followed by the computer software/services group at 28.01 percent.
The top group in the S&P 500 is financial stocks (20.50 percent), followed by information technology (16.20 percent). In terms of growth stocks, the technol- ogy industry offers far more opportunities than the financial services industry.
Microsoft (MSFT) is the most heavily weighted indi- vidual holding in the Nasdaq 100 and the second most heavily weighted in the S&P 500. Because it accounts for a large enough percentage in both indices, MSFT has a relatively muted effect on the spread between the two.
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The Nasdaq 100 is comprised of the 100 largest companies trading on the Nasdaq (financial companies are excluded), based on market cap. The index is heavily weighted with technology stocks.
TABLE 2 NASDAQ 100 COMPOSITION
Top stocks Top groups
1. Microsoft Corp. 10.15% 1. Computer & office equipment 28.39% 2. Intel Corp. 5.10% 2. Computer software/services 28.01% 3. Cisco Systems Inc. 4.49% 3. Telecommunications 11.69% 4. Amgen Inc. 4.28% 4. Biotechnology 11.45% 5. QUALCOMM Incorporated 3.65% 5. Retail/wholesale trade 9.86% 6. Dell Computer Corp. 3.24% 6. Health care 4.51% 7. Comcast Corporation 3.07% 7. Services 3.16% 8. Oracle Corp. 2.82% 8. Manufacturing 1.94% 9. eBay Inc. 2.65% 9. Transportation 0.99%
10. Nextel 2.48%
Communications, Inc. Source: www.nasdaq.com 6/30/03
Nasdaq E-Mini (NQ), weekly
S&P 500 E-Mini (ES), weekly
NQ-ES spread, weekly
Divergence between S&P 500 and Nasdaq 100
Rising spread is bullish
April July October 2003 April July
1,500 1,250 1,000 1,000 800 300 200 100 0
Calculating the difference between the Nasdaq 100 E-Mini futures (top) and the S&P 500 E-Mini futures (middle) results in a spread chart (bottom) that shows when one index is outperforming the other.
FIGURE 1 THE SPREAD PERSPECTIVE
Because of its large technology component, in an expanding economy the Nasdaq 100 should lead (i.e., rise at a faster rate than) the S&P 500 when the overall market is moving higher because more money man- agers and investors will be attracted to the potential of growth stocks. On the other hand, in a declining eco- nomic environment, financial services companies offer a safe haven for money (plus, many financial compa- nies pay dividends). That will tend to pull money away from Nasdaq stocks and into S&P stocks. As a result, the Nasdaq 100 should lead the S&P when the market is moving lower, as well.
In other words, a bullish stock market is reflected by an uptrending Nasdaq 100-S&P 500 spread (the Nasdaq 100 price minus the S&P 500 price). A bearish stock market will be characterized by a downtrending Nasdaq 100-S&P 500 spread.
Weekly perspective
Figure 1 (p. 71) shows the Nasdaq 100-S&P 500 rela- tionship from the fourth quarter of 2002 into the second quarter of 2003. The top and middle charts show the Nasdaq 100 E-Mini and S&P 500 E-mini futures, respec- tively, while the bottom panel shows the spread between the two.
Both the Nasdaq 100 and the S&P 500 futures con- tracts reached new lows in October 2002. However, during the fourth quarter of 2002, the Nasdaq 100 embarked on a substantial rally, bettering its July 2002 high; the S&P 500, however, was unable to surpass its summer (August) high. The Nasdaq-S&P spread jumped sharply higher, reflecting the Nasdaq 100’s more accelerated rally. Both markets peaked in December 2002 and moved downward until February.
The Nasdaq-S&P spread made a slightly lower low in January, just below its December low. As the S&P 500 moved lower, the spread started to climb again, reflecting the Nasdaq 100’s outperformance relative to the S&P 500. The Nasdaq 100 made the second low of a double bottom in March 2003, at which point both markets rallied into June. The developing spread relationship signaled this period of strength in the over- all market: The spread bottomed in October and began form- ing a series of higher highs and higher lows, indicating a bull- ish market environment based on the better performance of the Nasdaq 100 relative to the S&P 500.
Divergence on the daily time frame
In addition to gauging the relative strength of the indices when they are moving in the same direction, divergence between the Nasdaq 100 and S&P 500 on the daily time frame can signal potential market corrections. Figure 2 is a daily chart of the E- Mini Nasdaq 100, E-Mini S&P 500 and the spread between the two.
Line A shows the Nasdaq 100 rising to slightly higher highs in May while the S&P 500 surpassed its early May highs by a wider margin (approximately 1.28 percent vs. .87 percent, based on closing prices on May 6 and May 15). The spread (see line C) was flat between these two peaks, indicating the Nasdaq 100 was no longer outperforming the S&P. This situa- tion was followed by a short correction into the week of May 19.
Moving forward, the Nasdaq 100 peaked in early June while the S&P 500 peaked in mid-June. This divergence, indicated by the declining spread (line F), was part of another correction that lasted until the end of the month.
In July, the Nasdaq 100 surged to new highs, while the S&P 500 made a lower high. This divergence preceded a correction in the broader market. (Interestingly, though, the spread itself surged to new highs, which reflects leadership on the part of the Nasdaq and should be a longer-term bullish sign.)
The spread does not necessarily indicate a correction is com- plete; it does not wave a red flag. Nonetheless, there is value in being alerted to conditions that signal a potential correction.
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Nasdaq E-Mini (NQ), daily
S&P 500 E-Mini (ES), daily
NQ-ES spread, daily
New high A B C D E F G H 21 1 12 19 27 2 9 16 23 1 14 21 28 1 May June July Aug.
1,300 1,250 1,200 1,150 1,100 1,000 950 900 300 275 250 225 200
The growth-oriented Nasdaq 100 tends to lead the S&P to the upside as well as the downside. When it doesn’t, as was the case at points C and F, this lack of leadership can result in trend weakness in the overall market.
FIGURE 2 HIGHLIGHTING LEADERSHIP
Intraday applications
On a very short-term basis, the Nasdaq-S&P spread can help keep you on the right side of intraday trends. The same basic guideline holds, in that the Nasdaq 100 should lead the way, both up and down.
Although simple trend analysis, such as drawing trendlines, can help to spot changes, intraday spread charts, like individual markets, are very volatile. For example, during the latter part of June 2003, the stock market was moving sideways.
On July 1, the market broke key support levels, but the spread did not break its equivalent level. As the market began to recover, and moved back up through the previous broken support level, the spread broke the down trendline shown in Figure 3 . The Nasdaq 100 and the S&P 500 did not break their trendlines until later in the session.
Majority rules
Analyzing the Nasdaq 100-S&P 500 spread relationship reflects the idea that if the majority of stocks are not ris- ing — or, if the market-leading stocks are lagging the broader market — the trend may lack staying power.
The spread between the Nasdaq 100 and the S&P 500 can function as a gauge of how healthy or weak the overall market is. If one of the major indices is not keeping pace, the spread will fail to make new highs or lows. In those situations, watch for a trend change.
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Nasdaq E-Mini (NQ), 30-minute
NQ-ES spread, 30-minute
Support Support Support T1 T1 T1 25 26 27 30 1 2-8:30 July 1,250 1,225 1,200 990 980 970 960 250 240 230 220
Although intraday price data is more volatile than daily or weekly data, the Nasdaq-S&P spread relationship reflects the same dynamics. Here, the spread (bottom) pushed above its downtrendline before the Nasdaq or S&P futures did.
FIGURE 3 INTRADAY INSIGHT
Source: CQG, Inc.