The RPP Report: Review. Preview. Profit. (09-22-2020)

From the desk of Steve Strazza @Sstrazza

At the beginning of each week, we publish performance tables for a variety of different asset classes and categories along with commentary on each.

Looking at the past helps put the future into context. In this post, we review the relative strength trends at play and preview some of the things we're watching in order to profit in the weeks and months ahead.

Our last RPP report took a deep look at the damage endured by the most important assets in the world during the recent selloff.

We held this report back a few days this week because the S&P just broke beneath our risk level and was in correction territory, down roughly 10% from its highs intraday on Monday. We wanted to see how things would shake out, and we're glad we did. Let's talk about it.

While many areas have held up quite well and are showing signs of a near-term bottom, there has definitely been technical damage endured by others. After a few months of broadening participation to the upside, we're once again transitioning to a more bifurcated market, especially among US and International Equities.

We also believe we could be shifting to a more trendless and choppy market at the Sector and Index level in the coming weeks to months.

Let's start by looking at the US Indexes, which have become even more of a mixed bag during the recent selling pressure.

First of all, Micro-Caps $IWC booked a hefty 5% gain during what was another rough week for the Large-Cap Indexes. Dow Transports $DJT and Small-Caps $IWM also performed well. Transports actually made a slight new all-time high, but quickly reversed lower.

Fast forward to this week and those same leaders are all down big and have given back all of last week's gains and more. Meanwhile, the Large-Caps have shown signs of life with the Nasdaq 100 up over 1.5% and S&P flat, with each printing two very bullish candles to kick off the week.

Here is an update on the S&P 500 $SPY which we've been using as a broad risk gauge for US Equities in recent weeks.

We had been eyeing the 333 - 339 zone as the first line of support. Prices broke beneath 333 late last week and followed through Monday, filling the February 24th gap and testing the June and July pivot highs before reversing and closing near their highs of the day. Prices followed through higher on Tuesday, confirming the bullish hammer candle, and are now right back beneath our risk level.

We can drive ourselves crazy with what support and resistance zones matter next at the index level, but the truth is things are just messy right now over short and intermediate-term timeframes.

We're better served focusing on the individual winners or losers. The famous Wall Street proverb, "it's a market of stocks, not a stock market," is as true today as ever.

Let's look through some other indexes to illustrate just how hot of a mess things are right now.

During selloffs or any time we're looking for a market low, whether a significant bottom (like March) or a potential short-term trough (like the present correction), we want to focus on the leaders for early signals of a change in trend.

The obvious example is the Nasdaq 100 $QQQ.

It's hard to imagine Equity Markets are under any serious pressure in an environment where the Nasdaq is above its July highs and recent closing low of 268. The Nasdaq has also shown some impressive relative strength in the past two days, with a nice reversal candle Monday and bullish follow-through today.

This is a positive development and in my opinion, strongly suggests the recent correction low has already been made.

Although, as long as we're below 280 a neutral approach towards QQQ is best for now. That said, we still want to bet on the strongest stocks within the index.

Let's check in on the laggards now, which provided early signs of deterioration prior to the recent selloff which we wrote about last week.

SMID and Micro-Caps, which have been underperforming the major large-cap indexes for years now, flashed bearish divergences at the recent highs, as well as in Q1 prior to the market crash. Louis wrote about these early signals from Micro-Caps in his post today. You can see the chart here and read the full post here.

Let's take a look at the Small-Cap Russell 2000 $IWM now.

Small-Caps recently broke below our risk level around 153 at their key pivot high from early June. As Mid-Caps $MDY had already violated that level, last week we posed the question as to whether they would catch up to Small and Micro-Caps, or vice versa.

It turns out, it was the latter, as both IWM and IWC have since followed MDY lower.

So, what's it going to take for things to get worse? If we break below the 2019 lows around 144, the risk is to the downside in IWM. If we're above 144 a more neutral approach is appropriate, but unless/until we reclaim 153, expect some choppy rangebound action in this index. Mid-Caps are also still holding on just above their 2019 lows with a similar-looking chart to Small-Caps.

Let's take a look at what's going on with our Sector SPDR ETF table now.

After being the prior week's laggard with an almost -7% drop, Energy was last week's top performer with a 3% gain. Not something you'll hear very often and likely not again any time soon as the sector already gave back all of last week's gains as it is down over -5% already this week.

We still want to be short Energy which you can read more about here.

How about the leaders? Discretionary $XLY, Tech $XLK, and Communications $XLC continued to get hit while money rotated into areas like Materials $XLB and Industrials $XLI last week. This trend actually began several months ago. Coming into the week, Materials were up 5% and 17% over the trailing month and quarter while Industrials were higher by 3% and 12%, respectively.

When you contrast this with the broader market which is down about -2% over the trailing month, the relative strength from these groups is even more impressive. Although, based on the action so far this week, it appears this recent rotation could be taking a breather as we've seen incredible outperformance from the former leaders, especially Tech and Discretionary.

While Health Care $XLV has been a leader looking back over several years, investors haven't really had the same gusto for it coming off the March lows, and sellers now appear to be taking control.

The biggest tell here was the fact that momentum was never able to achieve an overbought reading to confirm the new all-time highs. XLV is getting sold hard this week (-2.5%) and is now below our risk level at the Q1 highs. If price is below 105, the risk is to the downside for Health Care. We think the 2018 highs near 96 is the next logical level.

Here is Communications $XLC, which unlike Health Care, just defended support at its Q1 highs and is bouncing off this key level constructively this week.

If we're above 57 we still like Communications with a target at 68.

The bifurcated nature of the market is illustrated very well by these last two charts.

Communications just held above its key level of interest at the Q1 highs while Health Care just broke below its equivalent level.

For Communications, the bias is higher above 57. For Health Care, a neutral to bearish approach is appropriate now that price is trapped beneath overhead supply.