How Bad Can Things Be?

From the desk of Steve Strazza @Sstrazza

A major theme we've been hitting on in recent months is that we've reverted to an equity market landscape dominated by US Large-Cap Growth stocks. 

So we know that's where the strength has been. But up until March-May of this year, these relative trends had actually been favoring Small-Caps and Value, and even other parts of the world over the US.

So was this just a counter-trend rally, or the beginning of a sustainable rotation? The real answer is it depends where you look and how you look at it.

But we are definitely seeing some developments that suggest there could be a rotation back in favor of value-oriented and cyclical stocks in the near future.

This becomes particularly clear when we look at the relative trends of some of these groups vs the S&P. And if we see these industry groups break out on an absolute basis - which many of them already are - this could be the extra juice needed for a true relative trend reversal that would put value back in the driver seat.

Let's dive in and review some of these areas now!

The first area we're going to cover was actually our most recent Mystery Chart. As always, thanks to everyone who participated. It was an inverted chart of the Airlines ETF $JETS. Here's a look at the chart right-side up:

Overall the answers were mixed. Some wanted to buy the breakout (or sell the breakdown) while others wanted to fade the chart as it approached critical resistance (or support, rather).

So, those of you who thought the key level of interest would act as a barrier for prices were right... or at least have been thus far, as JETS dug in at this crucial area of resistance turned support at 21.50.

Why do we care about Airlines stocks right now? They have been the epitome of market weakness. They strongly suggest the reopening trade is, well, not really reopening at all...

So let's check in on how these companies are faring relative to the broader market:

Same story as the absolute trend. The bears had their chance. They can't seem to get it done though. As long as we're above those June pivot highs from last year, this isn't a disaster.

What matters most about this price action is that these are some of the weakest stocks in the WORLD right now, and sellers still can't quite take control. 

When the biggest laggards in the market are refusing to break down, that's some real information... And it's definitely not bearish. 

Before bears can grab a hold of the broader market, they need to start by knocking down the weakest areas. They've been trying for 6-months now and while they've had some wins, they haven't been able to cause much real damage. Unless we start to see more of it, things are likely just fine for stocks. 

So, what else can we look to for a gauge on global growth and relation... and frankly, just an economy that's "back-to-normal?" 

That's right... the Homeys!

After consolidating at our primary objective for several months, these home construction stocks have 'built a nice foundation' and look ready for a move higher off this key level. We want to be long if we're above 68 with a target of 96 over the next 3-6 months.

Here's a closer look at both the home construction and homebuilder ETFs:

Notice how momentum never reached oversold conditions during the recent corrective action. We like these groups a lot here and have covered both of these ETFs over the past week.

JC hit on the space and outlined a nice risk/reward opportunity in one of the ETF's holdings just yesterday.

But let's take this a step further and think about the implications of this action on the broader market... If homebuilders break to new highs, how bad could things really be out there?

And here they are relative to the S&P:

The ratio just defended former resistance turned support at the breakout level of a 13-year base that price recently resolved higher from. If this ratio is above 0.155 the bias is higher and Homebuilders are likely an area of leadership. And outperformance from this group of cyclical stocks is a characteristic of an environment where investors are embracing risk.

So, after several months of defense, is it time for the offense to take the field?

It's still a little soon to make that bet based on the weight of the evidence, but the stars are definitely aligning that way.

As for Lumber, it remains a wildcard in our opinion. There's no use in overthinking the volatility there. 

Whenever there is an unnatural supply or demand shock, it throws a wrench in the true mechanics at play in a free market system. That’s how we feel about China and its impact on Emerging Markets right now too by the way.

Next, we have the Dow Jones US Restaurant & Bar Index $DJUSRU, hovering near record highs: 

Again... How bad can things be if restaurant and bar stocks are trading near all-time highs?