Last week the DOW and small caps outperformed the S&P 500 and NASDAQ.  It created an appearance of a positive divergence of breadth broadening.  A breadth broadening is needed for a true bull market.  But can a bull market be led by lower quality small cap stocks without the market leader such as Nvidia participating?  Nvidia had a terrific Q3 earnings report, but it failed to rally the stock.  We really have to ask ourselves why Nvidia can’t rally after a really terrific earnings report.  Could it be fully priced in all the good news already?  Or could be the general market meeting some sort of resistance?

No doubt, Nvidia has been the market leader for the entire 2023.  But right now Nvidia stock is contained in a double top formation.  In other words, it has been range bound.  When a market leader stalls, can the lesser quality stocks buck the trend against the leaders?  During the early phase of a bear market, certain sector of the stocks will seem to be gaining strength, creating the impression of a broadening lasting bull phase, but what you are seeing is just a postponement of the inevitable.  The Nvidia rally fatigue behavior gives us the early warning.  The year-end rally is slowing with Nvidia trading sideways.  In our last blog, we overemphasized that don’t trade on the short side.  It is still a bull market even though the rally is slowing down.

Another reason to suspect the durability of the small caps rally is Fed policy.  The Fed has told the market repeatedly that rate cut is NOT coming anytime soon.  Yes, the 10-year treasury yield has come down quite a lot due to the short squeeze in the bond market.  A lower 10-year treasury yield does create a little easier financial condition.  The Fed doesn’t set the 10-year treasury yield.  The Fed sets the short term Fed funds interest rates.  As long as the Fed keeps the short term Fed funds rates high, the small caps will have a hard time to survive.  The durable small caps rally really needs a Fed policy reset.  A Fed policy reset doesn’t come automatically because of the kindness of the Fed officials.  A Fed policy reset came because the Fed was forced to make a move in the past.  This time is no different.  We are waiting for an event to cause the Fed to pivot.

Next time when we hear about some kind of financial system troubles, something similar to the Silicon Valley Bank trouble back in March 2023, you will see the Fed jump into action to save the day.

It is our view that a true bull market will not start until the Fed pivots away from the tight monetary policy.  We don’t believe it would take long for the Fed to pivot because the small caps have been in a bear market since November 2021.  Underneath the magnificent 7 stocks, the rest of the 493 stocks have had a tough time for more than two years already.

Below is the S&P 500 weekly chart.

It is 5 weeks in the current weekly cycle.  It is approaching 4600 resistance level.  We are not shorting the market because it is approaching resistance.  We need to be patient to let this market top develop fully.  Sometimes a market top takes 9 months to fully mature.