From the desk of Steve Strazza @Sstrazza
In this week’s RPP Report we discussed some of the major developments recently such as the increasing bid for risk-on and reflationary assets, as well as continued rotation into more cyclical areas across all asset classes.
Our report focused mainly on Financials as well as some discussion regarding the recent outperformance from Small and Mid-Caps.
To follow up on this theme, today we’ll dig into some other economically sensitive areas like Mid-Cap Industrials and Materials.
We’ll take a look at the charts as well as the internals in these sectors in order to illustrate our current outlook.
Energy would also typically fall into this cyclical group, but we don’t want to touch that sector as the bias is lower. In fact, we’d rather be looking for short opportunities there if anything.
So let’s dive right in and start with the S&P Mid-Cap Industrials Index.
Price is currently failing at their former all-time highs from Q1 as momentum is waning with a potential bearish divergence. The near-term risk is to the downside for now.
The next support level we’re watching is 1,040. If we’re above it we’re likely to remain rangebound and correct through either price or time.
On the other hand, if we’re below that level it would represent the first lower low since the Q1 selloff. Under this scenario, the index is a no-touch as it would incur some structural damage and we’d want to approach it with a bearish bias.
Now let’s check out what’s going on beneath the surface in Mid-Cap Industrials.
Here is a chart showing the percentage of overbought stocks diverging lower since August despite price grinding to higher highs.
Before we go any further, I want to direct you to our post where we point out the cyclical breadth thrusts from Large-Caps in June and show the forward returns after such readings.
I highly recommend our Happy Hour With Traders Episode where we discuss these breadth thrusts and divergences in detail with some of the top technicians in the field.
Long story short, these extreme readings typically occur in the very early stages of a new cyclical bull market and create such a high-water mark that they are near impossible to be replicated. This often results in a series of bearish divergences in the roughly 2-3 years that follow. Over a long-term timeframe, they should ultimately be ignored.
Although on shorter-term timeframes they can be helpful to spot potential selloffs or corrections… which are likely to be buying opportunities under the assumption that we are in a new cyclical bull market.
With that out of the way, let’s move on to Mid-Cap Materials.
It’s the exact same story as Industrials, above. Price just ran into resistance and reversed at key former highs. Meanwhile, momentum has been unable to register an overbought reading recently and continues to wane lower, failing to confirm the new highs in price.
The next support level we’re watching is 412. If we’re above it we’re likely to remain in a messy environment in the short-term unless/until we get a sustained move above 474.
Alternatively, if we’re below that level it would represent the first lower low since the Q1 selloff. In this environment, the risk would be to the downside and we would want nothing to do with this index.
From a breadth perspective, we’re also seeing something quite similar to Mid-Cap Industrials.
This chart shows the percentage of overbought stocks in the Mid-Cap Materials Index remaining more or less the same since August while price makes slightly higher highs.
Again, while not quite as bad as the Industrials breadth indicator, it still doesn’t make us feel comfortable about the prospects for a breakout to new highs any time soon.
It’s also important to note that we are seeing similar potential bearish divergences in other indicators such as the percentage of new short/intermediate-term highs, among others. Here’s an example.
The main takeaway from this post is that not only are these Mid-Cap Indexes failing at their key former highs, but the internals are also confirming this weakness.
In our view, this suggests a period of choppy, sideways action for these indexes. Support for higher prices is just not there in the near-term based on a variety of breadth indicators we’re watching.
While this is not to say that things are going to fall apart from here, the weight of the evidence suggests a choppy, sideways market in the coming weeks/months.
We want to stay away until the dust clears and pay close attention to new data as it comes in.
If/when these indexes make new highs, these are areas we’ll want to be buying and looking for opportunities in.
For now, we’ll be keeping a watchful eye for whether that happens sooner or later… or not at all.
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