From the desk of Steven Strazza @Sstrazza and Grant Hawkridge @granthawkridge
Let’s flip the script this week and take a more granular approach to our analysis of market internals.
In recent months, we’ve written at length about deteriorating breath. While it’s been our position that the divergences in these indicators are normal following an onslaught of initiation thrusts like the ones we had last year, the lack of participation beneath the surface was drying up to levels that were simply not sustainable.
This lack of confirmation has caused many to question the new highs from the S&P 500 and other major US averages. But, the major averages have masked the pervasive weakness we’ve already been experiencing beneath the surface this year.
In last week’s post, we discussed this weakness in breadth and posed the following question:
Perhaps we’ve already seen the market correct beneath the surface. Maybe that was it…
As many of you know, something we’ve been working on internally is using various 'bottoms-up' tools and scans to complement our top-down approach. It's really been working for us!
One way we’re doing this is by identifying the strongest growth stocks as they climb the market-cap ladder from small, to mid, to large - and ultimately mega-cap status (over $200B).
Once they graduate from small-cap to mid-cap status (over $2B) they come on our radar. Likewise, when they surpass the roughly $30B mark, they roll off our list.
But the scan doesn’t just end there. We only want to look at the strongest growth industries in the market as that is typically where these potential 50-baggers come from.
Non-members can get a quick recap of the call simply by reading this post each month.
By focusing on long-term, monthly charts, the idea is to take a step back and put things into the context of their structural trends. This is easily one of our most valuable exercises as it forces us to put aside the day-to-day noise and simply examine markets from a “big-picture” point of view.
With that as our backdrop, let’s dive right in and discuss three of the most important charts and/or themes from this month’s call.
A little more than a month ago, we began to see broad-based strength in USD emerge on both a short and intermediate-term basis.
Since then, it’s been the central theme in currency markets.
But we're starting to see signs that this near-term US dollar dominance could be fading as bulls have had ample opportunity to push the USD higher in recent months but have made little progress.
The lack of follow-through can be seen in our long USD trade ideas from late June, as most are not working. We recently saw many crosses reach our risk level, but price rebounded instead of triggering an entry. The EUR/USD is a great example of this.
This is one of our favorite bottoms-up scans: Follow The Flow. In this note, we simply create a universe of stocks that experienced the most unusual options activity — either bullish or bearish… but NOT both.
We utilize options experts, both internally and through our partnership with The TradeXchange. Then, we dig through the level 2 details and do all the work upfront for our clients. Our goal is to isolate only those options market splashes that represent levered and high-conviction, directional bets.
We also weed out hedging activity and ensure there are no offsetting trades that either neutralize or cap the risk on these unusual options trades. What remains is a list of stocks that large financial institutions are putting big money behind… and they’re doing so for one reason only: Because they think the stock is about to move in their direction and make them a pretty penny.
What we do here is take a chart that’s captured our attention, and remove the x and y-axes as well as any other labels that could help identify it.
This chart can be any security, in any asset class, on any timeframe. Sometimes, it’s an absolute price chart. Other times, it’s on a relative basis.
It might be a ratio, a custom index, or maybe the price is inverted. It could be all three!
The point is, when we aren’t able to recognize what’s in front of us, we put aside any biases we may have and scrutinize the price behavior objectively.
While you can try to guess the chart, the point is to make a decision…
So let us know what it is… Buy, Sell, or Do Nothing?
We've already had some great trades come out of this small cap-focused column since we launched it late last year and started rotating it with our flagship bottoms-up scan, "Under The Hood."
To make the cut for our Minor Leagues list, a company must have a market cap between $1 and $2B. There are also price and liquidity filters. Then, we simply sort by proximity to new highs in order to focus on the best players.
Check out this week’s Momentum Report, our weekly summation of all the major indexes at a Macro, International, Sector, and Industry Group level.
By analyzing the short-term data in these reports, we get a more tactical view of the current state of markets. This information then helps us put near-term developments into the context of the big picture and provides insights regarding the structural trends at play.
Let’s jump right into it with some of the major takeaways from this week’s report:
* ASC Plus Members can access the Momentum Report by clicking the link at the bottom of this post.
Our Top 10 report was just published. In this weekly note, we highlight 10 of the most important charts or themes we're currently seeing in asset classes around the world.
Island Reversals And Interest Rates
One of the biggest things the bears have going for them right now is the fact that the 10-Year Yield is trapped beneath the critical 1.40% level. As long as that remains the case, the trend is lower for rates, and higher for US Treasuries. But we want to stay keenly aware of any signs of a trend reversal as we continue to see a barrage of mixed signals when it comes to risk appetite around the globe.
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.
From the desk of Steve Strazza @Sstrazza and Ian Culley @Ianculley
We can’t ignore the resiliency in base metals.
Despite the classic year-two chop, base metals have remained buoyant while many other risk assets have come under pressure. They’ve even gained ground during the recent bout of US dollar strength.
And now we’re beginning to see signs of serious leadership emerge as Crude Oil consolidates its recent gains. The broad-based strength beneath the surface for this procyclical group of commodities has been undeniable. These risk-on metals have been the steadiest performers within the entire asset class for the better part of this year.
This is a new development that's commanding our attention right now, mainly because these are the weakest conditions we’ve seen many of our breadth measures since last year.