Market's Fate Lands in the Small-Caps' Court

The major indices have established testing zones that will determine the ultimate fate of the bounce off the Bear Stearns (BSC - commentary - Cramer's Take) low. Although prices have pulled back sharply in the last few days, the battle between bulls and bears at these clearly defined inflection points might still go on into mid-June.

The Nasdaq 100 is the outlier there, with lingering strength in a handful of tech giants providing support and lifting the index above its 200-day moving average. But its superior performance has a downside, because it has triggered a plethora of bearish divergences when compared with the S&P 500, Russell 2000 and other indices.

Obviously, there's another complication in reading the position of the major averages and prognosticating direction into the summer months. Crude oil is surging higher in a historic blowoff and giving an unnatural lift to energy stocks. This phenomenon is distorting market numbers, as it has for several years now.

A few bulls still argue that rising crude oil will help, rather than hurt, prospects for a recovery in the major indices. But common sense dictates the opposite conclusion. Besides the obvious drag on consumer spending, the financial markets hate uncertainty. In this context, the jaw-dropping rise in energy prices must be interpreted as highly negative.

The Big-Cap Tech Effect

Let's also consider the surge in big tech compared with price action in other market groups. Back in the 1990s, narrowing leadership showed its face when the Dow Industrials moved higher, while the S&P 500 and Nasdaq Composite lagged far behind. The correlation was considered to be bearish, because the Dow marked the last safe haven before investors pulled in their reins and let the markets fall from its own weight.

The Nasdaq 100 has taken over that safety net as we head into the end of the post-millennium decade, with its household names providing the same sense of security offered by Coca-Cola (KO - commentary - Cramer's Take), General Motors (GM - commentary - Cramer's Take) and other Dow components in prior years. But the dynamics remain the same, i.e., thin leadership is a precursor of lower prices.

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At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.

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