From the desk of Steven Strazza @Sstrazza and Grant Hawkridge @granthawkridge
Let’s flip the script this week and take a more granular approach to our analysis of market internals.
In recent months, we’ve written at length about deteriorating breath. While it’s been our position that the divergences in these indicators are normal following an onslaught of initiation thrusts like the ones we had last year, the lack of participation beneath the surface was drying up to levels that were simply not sustainable.
This lack of confirmation has caused many to question the new highs from the S&P 500 and other major US averages. But, the major averages have masked the pervasive weakness we’ve already been experiencing beneath the surface this year.
In last week’s post, we discussed this weakness in breadth and posed the following question:
Perhaps we’ve already seen the market correct beneath the surface. Maybe that was it…
The major averages are simply not a good representation of what US stocks have been doing for the past 6 months. So why do weak internals have to result in any significant downside for these indexes?
We don’t think they need to. In fact, we’ve seen breadth improve in recent weeks and we’re now seeing expansion in favor of the bulls again.
In today’s post, we’ll discuss these new developments with a focus on those areas that had been exhibiting the weakest internals - value and cyclical groups.
We’re seeing it in price at the sector and index level. And now, we’re also seeing strengthening internals in these groups confirm this price action.
Here’s a look at the percentage of stocks above their 50-day moving averages for some of these sectors:
We saw a sustained period of weakness in recent months for these cyclical sectors. This is illustrated by the deterioration in these indicators that began back in April-May. However, the percentage of components trading above their 50-day moving averages has started to climb again, and in the case of industrials and materials, we’re now at levels we haven’t seen since June.
This expansion in participation is supportive of the recent price action from these groups as they've tried to repair some of the damage at the sector and index level.
We are also starting to see a tick higher in new 21 & 63 day highs for these cyclical/value sectors:
While this is nothing to get too bulled up over just yet, it’s a step in the right direction.
Does this mean we are going to see a reversal in favor of value?
We certainly could. But we need to see continued improvement and follow through before we’re ready to make that call.
What we do know is that things appear to be headed that way. We’re seeing these indexes try and rebound on an absolute basis. At the same time, many are also catching support at key levels relative to the broader market.
The seeds are now planted for a relative trend reversal. A sustained rotation into cyclicals would be a feather in the hat for bulls and speak to increasing risk appetite among market participants. All good developments.
Looking out over the coming months, we feel that these stocks have the wind at their backs, and this would be a logical time and place for them to reassert their leadership.
Bears had every chance to knock these underperformers lower while breadth was weakening… They couldn’t do it. Now, we’re seeing breadth turn a corner.
And most important of all, this could be the fuel the broader market needs to kick off the next stage of what we believe is a new bull cycle.
But for now, it's still a mixed bag and there remains work to be done.
So, is this just a counter-trend rally and these internals eventually roll over and turn lower?
Or, are these current conditions indicating the beginning of a sustained rotation where we’re likely to see a more significant move to the upside in the coming weeks and months?
We simply don’t know yet, but we'll monitor the new data as it comes in each day with an extra close eye on these areas to gauge which is the most likely outcome.
