We here at Normandy Research are firm believers in the ‘Thinning Hair Theory’ of the bull market.
You heard me…
That’s right. You never heard of it?
The ‘Thinning Hair Theory’ of the bull market goes like this…
Just like an old codger who begins to lose his hair and is forced to do a cavalier sweep over his bald spot with the remaining strands to cover up that embarrassing sheen, so, too, does the bull market sweep and cover as it gets on in years.
As the bull rises to its pinnacle, the number of issues that carry it there begins to thin. An index like the Dow feels it less, perhaps, because it has fewer components, those components are generally better known and therefore present less risk to the index as a whole when the number of rising issues begins to contract.
The S&P 500 on the other hand, stands to suffer considerably more, composed as it is by a great number of less-than-household names that will promptly weigh it down as investors concentrate their purchases on the sexiest issues available, those that possess the best PR machinery and are therefore more widely touted and written about in the financial media.
Interestingly, the NASDAQ Composite falls somewhere in between the two aforementioned indexes because 1) it’s comparatively large, like the S&P 500,
with 100 issues on the docket, and 2) because it’s a weighted index, with greater heft assigned to its biggest components, like Apple, Microsoft, Facebook, etc.
For that reason, the NASDAQ will happily move higher in line with its biggest members, while the bottom two thirds or more are liable to meander and forage about before they eventually disappear altogether from the investment landscape.
What’s it all mean, Huey?
Well, in the first place, all you index investors out there will continue to profit from the ongoing bull market, but not as wildly as if you position yourselves in one of those ‘thinning hair’ issues that are doing all the meaningful tonsorial work these days.
The chart below, courtesy of FBN Securities, demonstrates how obvious this tendency has become of late.
Take a look –
All the moves higher over the last nine months have been more or less commensurate with the gains of the average index stock. But the action off the July bottom had a distinctly different flavor (red circle). There, the ascent was founded upon a comparatively narrow number of issues that left the rest of the market in the dust. Kind of an exaggerated cowlick, if you will.
The chart shows that the masses are catching on. We’re no longer the only outlet writing about the phenomenon, though we were certainly the first. And certainly no one has yet found as good a name for the issue as we…
Just a week ago, Bloomberg News chimed in on the matter, reporting that over 100% of the year’s gains to date have come courtesy of the health-care and retail sectors, highlighting the tightest concentration of advancers in fifteen years, according to data compiled by Bloomberg.
The day before that, the Wall Street Journal weighed in with an aptly titled piece called ‘The Only Six Stocks that Matter’, in which they went a step further and named names.
The story, according to them, is that the following six issues account for more than half of the S&P 500’s market-capitalization gains this year: Amazon, Google, Apple, Facebook, Gilead and Walt Disney Co.
That’s one a helluva fact.
Now look here –
This is the same phenomenon described above, only with the NASDAQ as the focus, and the chart leaves no room for doubters. From the end of April the number of declining issues vastly outpaced those that were rising, yet the market still advanced. That in itself is not a Biblical wonder. If lots of stocks decline a little and a few heavyweights advance a lot, you’ll see net gains.
What’s stunning, however, is the sheer swan-dive plummet in advancers in July – within the blue frame – and the concurrent steep climb to new highs on the index. That can only be accomplished on the NASDAQ, to be sure, and only with the participation of the biggest names.
There are only two possibilities going forward. Either 1) the rest of the market catches up to the leaders and we advance safely into record territory, or 2) the trend continues in bifurcated fashion, and we get closer to seeing the bubble finally burst in the not too distant future.
In the event of the latter we can only say, be careful. Because it’s a near certainty that no one will notice the market’s thinning breadth before – poof! – the big guns will take their profits – poof! – the indexes will turn over, and pow! pow! pow! – the little guys will line up to take it in the head.
So how do we play it, wise one?
First, let’s take a closer look at some of those issues that are a driving the indexes hardest.
The above pictured pack of thieves is among the group to watch for as we head for the top. This is where the greatest profits will lie, and this is where we should be focusing our investment efforts.
It’s hard to know which will perform best, but our favorite remains the world’s biggest time-waster, friend to spy agencies and bureaucrats the world over, lover of dictators and bedfellow of the most autocratic regimes, Facebook (NASDAQ:FB).
Facebook stock is now recovering after an overbought condition was registered just over two weeks ago (in red, below). She’s been drifting sideways to lower ever since, awaiting a new opportunity, apparently, to once again storm the ramparts.
Here’s the chart –
We believe that all the sound and fury surrounding the latest overbought RSI read is overdone, and similar to the action in the summer of 2013, signifies nothing.
Then, Facebook gapped higher on massive volume, and never looked back. Today, the move lacks all signs of the extremism that obtained then, so we’re inclined to remain bullish.
And we’re playing it simply –
Look for FB to outperform the S&P 500 over the next twelve months; buy the former and sell the latter.
Wall Street Elite recommends you purchase the FB March 115 CALLs for $2.75 and sell the SPY March 222 CALLs for $2.79. Your credit is $0.04 per pair
With kind regards,
Hug L. O’Haynew, Senior Analyst