Regardless of the reasons, the message was clear - the bears continue to possess the upper hand. There was something in the violent reversal as stocks staged their latest feeble rally that rattled investors. TRIN of 3.34 with downside volume of 94% spoke to the forceful selling pressure, as internals registered one of their weakest days since the market peak. To say that Tuesday’s price action was disheartening would be an understatement, and while the action was ugly, history would suggest that some near-term relief is in order. As the charts below highlight, forward returns following such days (TRIN above 3, down volume greater than 90%) tend to have a bullish bias in the near-term.
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Let’s start with the good news. For the first time since October 9th, the S&P 500 closed above its 50-day moving average, thanks to an overnight gap through both that level as well as its 200-day moving average. For me, the more significant line in the sand is the 2815 level - resistance that has rejected the prior two attempts at exhibiting some much-needed momentum. Interestingly, this is right where S&P futures reversed course overnight, given back nearly half their gains. While the bulls can take solace in today’s small victory, let’s not lose sight of the fact that despite today’s move, other indices are struggling to recapture their individual resistance levels, as the NASDAQ 100, Value Line, Russell Mid-Cap and 2000 indices closes below their respective 200-day moving averages. One look at the Russell 2000 chart and it’s fair to say that one of the better proxies for risk-on behavior remains particularly dubious of the consensus interpretation of recent events. Speaking of dubious, of all the equities, bonds, currencies and commodities on my screen, the one that I kept going back to today was the yield curve. Aggressively flattening below 15bps today, the spread between 10s and 2s sure looks to be throwing some cold water on what many felt was an ‘all-clear’ signal into year-end.
With small cap equities struggling to regain their mojo, I’m always on the lookout for green shoots in an otherwise challenging tape. While there are unfortunately few to highlight while rummaging through the wreckage, I do want to draw your attention to the slight improvement being exhibited by the long-suffering financials sector. Up 3.1% over the past month, compared with 0.6% for the Russell 2000, financials have provided the 2nd best performance behind utilities (yeah, I found that odd as well since they historically do not trade in a similar fashion) since late October. Many times, relative improvement will lead the absolute turn, which is why the sector’s breakout through a two-year downtrend is noteworthy. Make no mistake, the absolute trend for the sector remains damaged, but while the sector attempts to gain its footing at significant longer-term support, the relative improvement is a welcomed development. Insurance has been a standout on the long side (favorite names included in today’s note), but I have a difficult time believing that the sector can truly differentiate itself without the all-important banks participating - something that has yet to present itself.
Despite the market’s recent drawdown, trying to identify successful short opportunities remains a difficult task, but one where conviction can be bolstered when endorsed by multiple investment disciplines. Back in early September (Wolfe Fusion - Identifying Shorts at the Intersection of Multiple Disciplines) we published our inaugural list of shorts that benefitted from the confirmation of three distinct macro disciplines - Accounting/Strategy, Quant and Technical. The market has clearly been volatile since, but this basket of shorts has produced robust returns, with median performance of -16%, providing strong alpha when compared with the -7% return for the S&P over this timeframe.
I’m always intrigued when the charts of any financial asset appreciate in the face of skepticism - which is why I thought that it would be helpful to highlight a handful of retail names in Adrienne Yih’s Monthly Short Report (Sentiment Returning to Max Negativity). Of those with the highest short interest as a % of float (over 20%), the setups in DKS, PLCE, UAA and SCVL look particular interesting on the long side. Additionally, of those with the largest sequential increase, I’m a fan of COLM, ULTA and FL. Speaking of ULTA, one of Adrienne’s favorite names fundamentally, all-time highs in this tape is impressive to say the least.
It’s hard to look at the charts throughout energy and materials and question the outlook for global growth. On the cusp of a meaningful breakout just a month ago, the reversal in energy has been violent and has left a fair amount of damage in its wake. I had been intrigued with the sector since last summer, as the internal capitulation coupled with bearish sentiment seemed to dovetail nicely with the constructive trends in oil. The sector is once again oversold, but one should not ignore the recent technical damage, the commodity included. The question is, will this be an oversold rally that you want to sell? If the ensuing rally is meek in nature and lacks the usually bullish momentum that has accompanied rallies since last summer’s low (the rally off the October 29th low would definitely fall into this camp so far), I’ll have no choice but to reverse what has been a constructive view.
Well, the multiple oversold signals finally took hold, as the February lows for small and mid-caps have held…for now. A welcomed short-term sign as the calendar turns from foe to friend but make no mistake – these indices have suffered substantial technical damage, rattling the underlying foundation that has been so resilient over the past 30-months. I’ll be keeping a close eye on how the Russell handles the 1600-1620 resistance level – an important first test as the current oversold rally attempts to gain momentum. The bulls need to respond, and they need to respond in dramatic fashion over the following weeks and months. Failure to do so and the recent test of the February lows will just be a speed bump on an eventual move lower.
I wanted to flag Chris Senyek’s Portfolio Strategy report from this morning (What’s Next? - Don’t Fear Peak Earnings; Use Market Volatility to Buy Global Cyclicals), in particular a bunch of compelling buying opportunities. Towards the back of his note, Chris provides a list of ‘over punished’ stocks that have underperformed the market in the current sell-off, but have reported earnings and seen positive EPS revisions. In addition, these companies have available buyback authorizations and a recent history of repurchasing stock. From a technical perspective each of the names are oversold, but I’m more inclined to play those that still have the underpinnings of a positive trend as opposed to those that have seen a meaningful deterioration. I’ve included his list, along with the charts of the best looking in my view.
Bottom line - the clock is ticking for stocks to respond. I’ve always found that the beauty of the charts is not only do they remove emotions during periods of intense volatility and uncertainty, but also provide a crucial message in how financial assets respond to their respective oversold environments. With respect to the latter, equities have brushed aside the multiple signs of near-term capitulation that have developed as price discovery appears lower. So where do we go from here? As the S&P rests on intermediate-term support that began off the February lows, a violation at current levels and a move back towards this year’s low (2532) seems like a fair bet at a minimum.
Retests of previous lows are never pleasant, but it’s an important step in the price discovery process as you search for bullish divergences to hint that some much-needed relief is in order. Fortunately, yesterday’s (10/24/18) early morning flush provided a few signs, as the % of oversold stocks and 1-month lows contracted sharply from their October 11th peaks. Said another way, the number of stocks driving the selling pressure yesterday was narrower in scope than a couple of weeks ago – usually a sign that the bears are close to exhausting themselves in the near-term. Thanks to the rapidly deteriorating foundation I do worry what the next 6-12 months has in store, but reversals in trend are a process. Maybe I’m being too cute (I know, famous last words), but oversold, with a strong seasonal tailwind on deck, I’d use ensuing rallies to my advantage.
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