Sunday, July 30, 2006

RSP and SPY: Unweighted and Weighted S&P 500 Index

With the Rydex equal-weighted S&P 500 ETF (RSP), traders can now trade a version of the popular market average that has performed quite well in recent history. (See today's entry in the Trading Psychology Weblog for a chart). Going back to May, 2003, for example, the weighted S&P (SPY) has been up about 39%. The unweighted RSP, however, has risen by almost 66%. What that's telling us is that the smaller components of the S&P 500 have outperformed their larger counterparts--which is exactly what we've seen with the outperformance of the small and mid caps relative to large caps over the same period.

During the past five days of trading, SPY has been up by 3.25%, but RSP has lagged a bit, with a gain of 3.07%. Since May, 2003 (N = 809), we've had 48 days in which SPY has been up more than 2.5% over a five-day period. Over the next five days, SPY has been up on average by .66% (33 up, 15 down). That is much stronger than the average five-day gain of .20% (454 up, 355 down) for the entire sample.

When we divide the strong SPY periods in half, however, based on RSP performance, a pattern emerges. When SPY is strong over five days and RSP is relatively strong compared to SPY (N = 24), the next five days in SPY average a large gain of .96% (17 up, 7 down). When SPY is strong over five days and RSP is relatively weak (N = 24), the next five days in SPY average a gain of .37% (16 up, 8 down).

In other words, a strong five-day period since May, 2003 has led to strength over the next five days, but that strength has been more pronounced when the small stocks in the S&P 500 Index have been outperformers (which has not been the case over the last week).

Once again, however, we do have to be concerned about changing cycles. Since the start of 2005, we've had 10 occasions in which SPY has been up by more than 2.5% in a five-day period. Five days later, SPY has been up 4 times, down 6, for an average loss of -.10%. In 2006, three of the four occasions in which we've seen a strong SPY (up more than 2.5% over five days) have led to losses five days later.