From the desk of Steven Strazza @Sstrazza and Grant Hawkridge @granthawkridge
Over the past few weeks we’ve seen a handful of major indexes, like small and mid-caps, resolve higher and kick off a fresh up leg. But breadth has really cooled off since then, as participation has been declining despite the major averages rallying.
This week, we’re finally seeing that weakness show up at the index level -- particularly from SMIDs and cyclicals.
When we were reviewing our breadth charts, we noticed the deterioration in energy sector internals has been particularly bad. Not only is breadth not confirming the new highs from energy stocks… but there are actually some pretty ugly divergences in our new high indicators.
Energy stocks are currently vulnerable, sitting just above their breakout level at former resistance. Considering the lack of support from internals, this group is on failed breakout watch.
Let’s take a look under the hood and discuss what we’re seeing.
Energy has been coiling in a continuation pattern above its year-to-date highs around 56 for over a month now. You can see this in the upper pane of this chart:
But when we look at the lower panes, we’re seeing the percentage of components above their 50-day moving average and the percentage of new 21-day highs falling off a cliff.
These are what we call breadth divergences. Price is moving higher/sideways, but the number of stocks holding their moving averages and making new highs is declining. These are not the kind of breadth characteristics that tend to accompany indexes at new highs.
In fact, it’s just the opposite. The persistent deterioration in energy breadth metrics throughout November is suggesting these new highs are not likely to be sustained.
We’re also seeing the same dynamic play out -- albeit to a lesser degree, within the industrials $XLI and materials $XLB sectors. Here’s what that looks like:
This weak action beneath the surface increases the odds that these new highs from XLB and XLI turn into failed breakouts.
And if it’s happening to these cyclical sectors, it’s likely happening to energy stocks too. You can throw financials in that category as well.
Long story short, some of the most important sectors and indexes are on the precipice of printing major failed breakouts and violating key former highs. And the information we’re getting from our breadth indicators supports this narrative right now.
The strongest rallies are fueled by robust participation across the board. Today, we’re seeing the opposite from cyclical stocks. This is the kind of breadth action we’d expect in a choppy environment, like the one we’ve been in for much of this year.
Maybe, we’re still not quite out of the woods yet. We’ll need to see some improvement beneath the surface fast if these breakouts are going to remain intact.
We’ll know more soon. For now, all of these sectors are on failed breakout watch. Their year-to-date pivot highs are the levels we're watching.
