Checking In On The Underperformers

JC Parets
August 28, 2019

This could be a major top in the US Stock Market. It could be a historic top like 2007 or 1929, maybe even 1987. This is certainly a possible outcome.

Something else to consider is that betting on these outcomes is rarely a profitable endeavor. They make movies about the heroes who bet heavily on the financial collapse of 2008 and made fortunes. We talk about these fund managers like legends. What they don't make movies about are the infinite number of investors over the years who have bet on such outcomes, and were wrong instead. I guess Hollywood doesn't think those stories will sell.

I understand the bearish thesis for US Stocks. In fact, we always take the other side of our opinions and try to poke wholes in a given theme. We've been in the camp that since most stocks have gone down to sideways over the past 19 months, this is a classic cyclical bear market. It has gone on through both price and time, not just one of the two. I don't care how you slice it, this was a bear market, and possibly still is.

Now, whenever in doubt, zoom out right? I think we can agree that the rallies of 2016 and 2017 deserved a rest. So the question is whether this "rest", or digestion of gains, if you will, is a distributive top that will lead to a much more substantial decline? Or is this a consolidation within an ongoing uptrend that we can argue began in early 2016 and, even longer-term, the 2009 lows.

Yes recession, and yield curves and the fed and trump and all that. Yes I know. We're going to focus on price, however, to figure out what's going on.

Ok, the large-caps have been leaders, particularly US Large-caps and Tech more specifically which represents approximately 25% of the entire S&P500. We get that. Today we want to focus on the areas that have NOT been participating. The market doesn't "need" these underperforming sectors to lead, but it does need them to at least participate. We've had neither so far.

We want to take the low in December in these underperformers and compare them to their highs earlier this year to see how much they've retraced. For me, it's not the lows from late May in $IWM that I'm concerned with, it's actually that 147-148 level. If we're above 148, I think the path of least resistance is higher, back towards 161 and even higher:

Click on Charts to Zoom in

Notice how Mid-caps did not break below their respective 38.2% retracement. There is interesting relative strength there among the non-large-caps. If we're above 332 in $MDY, we want to be betting on a retest of 361 and ultimately a breakout from there:

It's the Micr0-caps that have been the worst of the group reaching its 61.8% retracement near 85-86. If $IWC is above 86, I think the path of least resistance is higher back towards 100:

Notice in all 3 cases above, Momentum did not reach oversold conditions. These higher lows above 30 in RSI with prices hitting lower lows is consistent with higher prices in these 3 index ETFs. This is only valid, of course, if we're above the aforementioned levels.

On a similar note, I thought it was interesting that Financials also held above their 38.2% retracement of their 2018-2019 rally. If we're above 26 in $XLF, I like them higher:

If these levels start to break in these areas, I really like more cash on the books. This combined with the S&P500 breaking the December lows relative to both Gold and Bonds would make sense in an environment where stocks are going lower. You can watch this quick video I did on what is happening there.

It's the week before Labor Day. This one and next week are always funny and it's where whipsaws are born.

Be in touch if you have any questions, but this is how I see it right now.

JC

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