In yesterday’s piece we noted the widening divergence between the NASDAQ Composite (COMP) and NASDAQ 100 Indices (NDX). The two indices tend to correlate quite highly – the R-squared tends to be between 0.97 and 0.985 – but the more tightly focused NDX has been outpacing the broader COMP for years. The outperformance of NDX has pushed the spread between the indices to their widest ever, as evidenced by the chart below:
5-Year Line Chart, NDX (blue) vs. COMP (white)
Source: Interactive Brokers
The outperformance of NDX is easy to explain. That market-capitalization index is dominated by megacap technology stocks like Apple (AAPL), Microsoft (MSFT) and Nvidia (NVDA).  It’s been clear to everyone that those stocks have been the dominant leaders driving popular indices higher.  The theme of yesterday’s piece highlighted how NVDA has been driving intraday movements in NDX and the S&P 500 (SPX). Today is no exception, with NVDA and other semiconductor stocks benefitting from solid earnings at Taiwan Semiconductor (TSM). They, along with AAPL, are allowing NDX to rise just under 1% at midday while the broader SPX is up only 0.25%.Â
But we also cautioned against being too eager to enter into trades that assume that the gap between NDX and COMP will fully close. A close examination of the chart above shows that the relative outperformance of NDX was evident in 1999-2000, yet the gap didn’t fully close when markets collapsed in March 2000.  The same can be said for the 2021-2022 period. Major tech stocks led the 2021 advance, and while they actually fell more sharply in 2022, the gap never fully closed even then. As a result, if one is inclined to take the contrarian view that the largest tech stocks are due for a period of underperformance, don’t be greedy. The gap might narrow but not fully close.
Also mentioned yesterday was that Tuesday’s market showed how the largest tech stocks could paper over a broad market decline. We noted that on that day we saw NDX close -0.01% and COMP close -0.19% lower, even as decliners on that exchange outpaced advancers by a nearly 3:1 margin. This shows the power of the largest stocks. If they have a decent day, it can be enough to keep indices afloat.
A close look at the cumulative advance-decline line for the NDX component stocks versus the same statistic for the Nasdaq Exchange as a whole shows how the majority of stocks have been underperforming the more selective index. The total measure of advances-declines has been sinking steadily since the start of this year.  Meanwhile, the specific advance-decline line for NDX has only been modestly lower. It is dipping vis-à -vis NDX, but it is too early to call that a significant divergence.
2-Year Lines: NDX (orange, top left X-axis), Total Cumulative NASDAQ Advances-Declines (green, top right X-axis), NDX Cumulative Advances-Declines (blue, bottom)
Source: Bloomberg
When we look at the same chart using SPX and NYSE trading data, the divergences exist, but are far less noticeable than for NASDAQ:
2-Year Lines: SPX (white, top), Total Cumulative NYSE Advances-Declines (red, top right X-axis), SPX Cumulative Advances-Declines (blue, bottom)
Source: Bloomberg
The summary here is that there may be some nascent signs of weakening market participation, but if the megacap tech stocks can continue to deliver, then popular indices could continue to perform decently. Much will depend on this earnings season. If those stocks can continue to deliver, then money will continue to flow into them. And if not, well….
Disclosure: Interactive Brokers
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