From the desk of Steve Strazza @Sstrazza and Louis Sykes @Haumicharts
At the beginning of each week, we publish performance tables for a variety of different asset classes and categories along with commentary on each.
Looking at the past helps put the future into context. In this post, we review the relative strength trends at play and preview some of the things we’re watching in order to profit in the weeks and months ahead.
We discussed markets remaining more or less a mixed bag over recent weeks/months. At the same time, we've pointed out how the weight of the evidence continues to tilt gradually in the direction of the bulls, particularly due to the action we've observed in key risk assets.
This week, we saw that trade unwind a bit as most risk-assets were lower on the week. We're going to need to see a lot more data come in to support a sustained rotation into these more cyclical areas as well as reverse some of these long-term relative trends.
So, after a big week of progress, we're right back to an increasingly bifurcated market environment.
Let's jump right into it with our US index table.
All of the major indexes except the Dow Jones Utilities Average $DJU were down over 5% on the week.
This week we got clear data that reinforces our view that the evidence in the near term is increasingly choppy, mixed, and simply messy. Many of the indexes in our Universe are flirting with their crucial Q1 highs. At the end of the day, buyers need to defend these levels for the bullish thesis to remain intact into the fourth quarter.
The big level in the sand for us is the September lows in many of these indices.
Take the S&P 500 $SPY, for example.
The S&P 500 $SPY printed its first lower high since the March lows. The momentum of this uptrend has also cooled off, as the current RSI reading is at its lowest level since the March low as well.
Here's the bottom line: We’ve observed a serious change in character in the large-cap indexes recently. We can measure this in a number of ways. For example, S&P futures just registered five consecutive down days for the first time since the beginning of the COVID-crash in February.
Ultimately, we’re seeing a lot of bearish developments that we haven’t seen since Q1. We want to be extra cautious right now. If we’re below 338 and above 320, expect some choppiness in the near-term.
If we’re below 320, that would mark the first lower low since March. In this scenario, we think the risk is to the downside and would rather be on the sidelines. We really want to see the September highs reclaimed before being aggressively bullish.
Now let's take a look at how the Equal-Weight S&P $RSP is faring relative to the Cap-Weighted index.
Despite never reclaiming its Q1 highs similar to SPY, it has made a higher high recently while SPY has made a lower high, as just discussed. This is evidence of broadening participation and tells us that the mega-caps that drive the S&P 500 are starting to underperform the other, smaller stocks in the index. Not only that, but Mega-Caps are also underperforming Small, Mid, and Micro-Caps in recent weeks/months.
While Mega-Caps $MGC and many Large-Cap indices made their first lower highs since the first quarter, Small-Caps printed higher highs in October.
While Mega-Caps $MGC and many Large-Cap indices made their first lower highs since the first quarter, Small-Caps printed higher highs in October. The same can be said for Mid and Micro-Caps.
So, these two charts are showing increasing risk-on behavior.
This next one is not. Not at all, actually. Here are Dow Utilities and Dow Industrials looking back several months.
Utilities are a defensive area: they tend to follow bonds and do better in a lower yield environment. They are a safe-haven, not a risk-asset. This is one of the most concerning developments in recent weeks. Utilities are outperforming every other index by at least 2x over the trailing month.
Here is the Dow Jones Industrial Average $DJI relative to its Dow Utilities $DJU counterpart.
This ratio rallied aggressively off the March lows and in June, broke above the Q1 highs and a downward sloping trendline which had been intact since June of 2018.
Recently, however, the ratio has taken a sizable drop, placing it firmly below the Q1 highs. Again, this is another data point that is telling us the evidence is increasingly mixed – this ratio lies in the middle of a substantial range, with a serious short-term bias lower.
The recent rotation into Utilities is also illustrated well by the bubble chart below.
Not only are Utilities the top performer during the month of October, but they have also been outperforming the S&P 500 by about 14% since the indexes record high on September 2nd.
This impressive relative strength from Utilities over the past two months is definitely evidence of rotation into defensive areas. Utilities in the upper right, while Tech and Growth are in the bottom left with Energy, is not something we've seen in a long time.
Moving now to our Sector ETF table, here is an example of something that illustrates the exact opposite of what we're seeing from Utes.
Discretionary is at all-time highs relative to Staples and showing no signs of slowing. This tells us that investors would rather be in more economically sensitive and higher beta stocks than quality, low volatility, and high dividend-paying areas. So the two major bond-proxy sectors are currently giving us completely contradictory signals.
Which will be right? We don't know for sure, but we can weigh the rest of the evidence to determine our bias.
So, what's our Sector ETF table telling us?
There's a similar story to our US Index table. This past week, and the entire month really, has been a blood bath. Only Utilities are positive over the trailing month.
Many of the most important risk-on sectors are testing critical levels. This is the case with Industrials $XLI, Materials $XLB, and Financials $XLF.
It will be a major blow to the bullish thesis for equities if these respective levels don't hold.
So, while that is definitely one way to draw potential support over the near-term, let's zoom out and see how the picture changes.
While buyers are still defending those Q1 highs for Materials, the same cannot be said for Industrials and Financials. Again, a lot of this simply comes down to timeframe. Some chop in the meantime is the most likely scenario in our opinion, if and until these areas take out their resistance zones.
When we focus our attention to secular leaders, like Technology $XLK, they firmly remain above their Q1 highs.
However, on an Equally-Weighted basis, Technology $RYT closed the week below the February highs of $211.50. We're seeing similar bearish momentum divergences confirm themselves all over the place right now in key sectors and indexes.
One thing that remains quite impressive is that Tech vs the broader market has still yet to breakdown despite the underperformance from Tech over the trailing month.
Again, we’re looking at the first lower high in about a year. The year-to-date uptrend line has also been violated. Additionally, the momentum divergence from the July to September highs just barely confirmed this week.
