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 absolute and relative trends at play and preview some of the things we’re watching in order to profit in the weeks and months ahead.
In last week's report, we discussed the continued rotation into SMIDS, international markets, and risk assets. Our conclusion is and continues to be that the market remains in a very healthy state of order.
FICC markets are also confirming the move higher in equities.
From a short-term perspective, SMIDS digesting their recent gains would be a healthy development.
While we have yet to see that play out, our long-term outlook continues to favor Growth-oriented stocks down the market-cap scale as a way to express our bullish thesis.
Without further adieu, let's jump into this week's RPP Report with our US Index table.
Many indexes were flat for the week. Small-Caps $IWM booked the largest gain, further extending their lead over the trailing month and quarter.
Last week, we shared this chart of the Russell 2000 vs the S&P 500 $SPY, and had this to say:
Considering Small-Caps’ near-vertical advance, this seems like a logical place for some deserved digestion of the recent gains.
In the week since, buyers managed to decisively push the ratio above this key inflection point, revealing the strength of SMIDS and Micro-Caps.
While some backing and corrective action around this level is likely, it's a very bullish characteristic for consolidations to occur above critical levels, rather than below them.
The 0.05 level in the IWM/SPY ratio was our ceiling but is now our floor. We only want to bet on Small-Caps outperforming if this ratio remains above that crucial level - something we are definitely erring toward, but want to be patient as some corrective action is likely.
If you look at SMID indexes on an absolute basis, just about all of them are the most extended from their 200-day moving average than they've been in decades. Here is the Small-Cap Russell 2000 $IWM as an example.
The last few readings that came close to where we are now were in 2003 and 2009. Both occurred just after significant bear market lows and in the early stages of new bull markets. Will this time be any different?
Historic breadth and momentum thrusts like this continue to pop up left and right, and while they often suggest near-term caution, such a confluence of bullish initiation readings can only be viewed as a positive for stocks looking out over the intermediate to long-term.
On the other side of things, we're watching these potential momentum divergences in Large-Cap indexes closely. Here's a look.
Both the S&P 500 and Dow Jones Industrial Average failed to reach overbought conditions with their recent highs, indicating a serious deterioration in momentum.
Any meaningful downside would likely result in a violation of the September 2nd highs which would confirm these divergences across the board.
While we believe a breakdown is the lower probability outcome, if this occurs, a more neutral short-term bias toward these Large-Cap indexes would be warranted.
Mid, Small, and Micro-Cap indexes have yet to see such divergences and remain decisively in overbought conditions, further suggesting the alpha is in stocks down the market-cap scale.
Whether we're looking at ratios, price action, or momentum, it's all signaling a long-term relative trend reversal in favor of SMIDs right now.
Although, when we zoom out things look good on a structural basis across all cap-segments.
Take the Value Line Arithmetic Index, which is a representation of the average stock's performance. Here's what we had to say about it in October:
When you look back about a decade, you’ll notice that these consolidations are breaking higher within the context of very strong structural uptrends… and if there’s one thing we know about trends, it’s that they tend to persist.
The trend in the value line is doing just that.
Uptrend, consolidation, breakout... repeat. It sure looks like we're in the middle of a new uptrend phase now.
We'll be keeping an eye out to see whether Large-Cap indexes can hold their September highs, but the long-term view from an index perspective looks incredibly healthy and constructive.
Moving now to our US Sector table.
Everything but Energy was lower on the week as most Large-Cap sectors and indexes continue to consolidate and digest their gains from earlier in the year.
Notice who the laggards are over the trailing quarter - Staples $XLP, Real Estate $XLRE, and Utilities $XLU. The latter two are actually trading at fresh record lows relative to the S&P. Seeing defensive sectors underperform like this is a characteristic of bull markets and indicative of healthy risk-appetite for stocks.
With Energy $XLE being the standout over the last month and quarter, let's take a step back and put this move within the context of its longer-term trends.
For a relative strength perspective, here's a ratio of the long-term sector leader, Technology $XLK vs Energy.
After recently resolving higher from a 20-year base, the ratio is sitting right on top of former resistance turned support at its Q1 highs (see insert). The structural trend is undeniably higher.
Meanwhile, momentum failed to hit oversold territory on the recent pullback and there's a minor bullish divergence - all pointing in favor of Technology over Energy.
Energy could outperform Tech by another 20% and this ratio would still be above those key 2000 highs. The sector has endured so much structural damage since making its last all-time high over 5-years ago that it's going to take a lot of time and repair work before we want to be buyers again.
For now, we'd prefer to look for opportunities in leadership groups such as Technology, Communications, and Discretionary.
Here's what we had to say about Energy in a recent Institutional send-out:
This entire complex is still a mess, with just a handful of stocks back above their February highs. Most of these names are still trapped below substantial overhead supply. It’s hard to think there is any serious upside potential with so few stocks supportive of a sustained move higher.
On the other side, we still very much like Growth-oriented sectors.
Take the recent breakout in Communications $XLC relative to the S&P 500.
Communications is quite clearly in a sustained uptrend on an absolute basis and now appears to be reasserting itself relative to the overall market. We want to continue looking for new buying opportunities in this space.
Now for our Industry ETF table.
