From the desk of Steve Strazza @Sstrazza and Grant Hawkridge @granthawkridge
Bond yields are breaking higher across the board. So, it’s essential to understand that some stocks do better amid rising rates, while others prosper in markets with low growth and low yields.
For instance, cyclical and value stocks should outperform in a rising rate environment.
Meanwhile, growth, tech stocks, and any long-duration assets (bonds) typically lag. They become less attractive during periods where more economically sensitive areas offer more appealing opportunities.
And we’re already seeing this rotation into the rising rate beneficiaries, while growth stocks have come under pressure in recent weeks.
In today’s post, we’ll look at market internals of these groups to see what they suggest about recent price action.
We can compare growth to cyclicals by analyzing the ratio of Large-Cap Tech $XLK to Energy $XLE.
And we can further illustrate this growth-versus-value relationship through a variety of derivatives. They all tell similar stories.
Right now, Energy is the only sector that's up September, with a gain of nearly 10% gain. Meanwhile, Tech has been among the weakest performers, with a 5% loss. So we’re just isolating the leader and laggard within each factor.
In the lower pane, you can see the percentage of components within each sector that are above their 50-day moving average:
First of all, how about the ramp-up in participation from Energy stocks since July. The metric basically went from 0% to 80% in less than two months.
Technology stocks, on the other hand, look quite different. We’ve seen a persistent deterioration in this metric throughout 2021. Back in January, 90% of technology stocks were above their 50-day moving average. As of yesterday's close, that figure was down to 29%.
Not only is the breadth for these groups moving in different directions right now; we’re seeing the same dynamic in price, as the XLK/XLE ratio is rolling over beneath a key level of interest (top pane).
And we're also seeing evidence of healthy breadth expansion from our short-term new highs indicator for Energy:
This is only 21-day highs, really nothing to get super bullish about just yet. But it's a step in the right direction.
Seeing this reading spike to levels not seen since earlier this year could be a sign of a new initiation phase for these stocks. If that's the case, we’ll see similar surges in our longer-term new high indicators in the coming weeks and months.
For now, breadth is supporting this tactical leadership and bullish action from Energy stocks. We see this as a healthy market development, as it speaks to increasing risk appetite.
Let’s check in on how the other cyclical, or value, sectors are doing.
Here’s a combined look at the percentage of Financials, Materials, Industrials, and Energy stocks above their 50-day moving averages:
Although the other sectors haven’t been as strong as Energy, this indicator still made a powerful move back above 50% in recent weeks.
Strong action beneath the surface adds weight to the narrative that we could be in for a sustained period of outperformance from these stocks.
And would it really be the worst thing to see growth stocks go sideways, or even correct lower for a bit, after the run they’ve had?
Actually, that would be normal.
Current conditions are ripe for value stocks, and internals are supporting the action we’re currently seeing. Now we just need to see it confirmed by price.
Groups like Industrials and Materials have some serious work to do, as they’re both testing the lower bounds of their year-to-date range. If this move in rates is for real, we’re likely to see these levels hold as participation branches out to these groups.
We think that’s the most likely outcome.
But, as always, the market will do what it wants to do…
In the meantime, we’ll do what we want to do, too, and keep monitoring new data as it comes in each day. We’ll be keeping an extra-close eye on these areas and the growth-versus-value relationship in order to gauge where the alpha is in the stock market.
