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.
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Closing in on their lowest relative level in nearly two-years, financials remain one of the most frustrating sectors in the market today. Something has clearly been plaguing them for quite some time (see my prior notes below) - unable to exhibit any semblance of sustainable upward momentum despite the bulls getting their long-awaited backup in rates coupled with a healthy economic environment. The curve has clearly provided a stiff headwind, but it is worth asking yourself what one of the most consensus longs entering the year is signaling.
They just don't act right. While industrials (trade war concerns), tech (F.A.A.N.G.) and consumer (rebirth of retail?) garner all the headlines, what’s taking place over in the financials sector warrants some increased attention – global banks in particular. European banks have been an issue since the fall and remain some of the worst looking charts in the market today, but it is the increasingly vulnerable setups in important names such as GS, C, JPM, MS and BAC (check out the equal-weight chart of these names below) that I keep coming back to on my screen. I’m not one that needs to see financials lead – inline performance would be ok with me – it’s the meaningful divergence to the downside that has been troubling. Now for some good news: each of these bellwethers is either oversold or very close as we approach the most favorable month of the year from a seasonal perspective.
Something just doesn’t feel right with global financials. Banks in particular remain under considerable pressure and seem to be sniffing out growing risk in the system. Whether it’s in emerging markets, Europe, or Australia, banks look increasingly distributive, as many well-known franchises trace out significant tops. Yes, it’s better in the U.S., but one has to question why relative performance has been peeling off recently even as the bulls finally got their long awaited breakout in yields through 3%. Small has been much firmer than large, as bellwethers such as Goldman and Citigroup look trace out tops, but on a relative basis, the struggles across the capitalization spectrum remain. Let’s hope my mounting anxieties are simply misplaced – I just wish credit wasn’t starting to come my way
While digesting their recent oversold gains, domestic financials continue to act reasonably well. Although banks grapple with the short-term contraction in the long-end of the yield curve, capital markets continue to impress with a fair number of names accelerating to absolute and relative highs. What worries me, and what has been a growing concern for months, is the distributive price action of the European financials, the banks in particular. Credit metrics remain firm, while many constituents within the Euro STOXX Banks Index (SX7E) are tracing out meaningful tops. For now, their ailments are confined overseas, but take one look at the chart of Deutsche Bank (among others), and it’s clear that something isn’t right.
So much has been made of the banks benefitting from higher yields - if only it was that easy. While the backup has provided a healthy tailwind for the larger cap names, despite this consensus view, small and mid continue to languish on a relative basis. Concerns around loan growth has been an issue that some have highlighted, but we remain puzzled by their persistent underperformance. For those looking to increase exposure, momentum would suggest to continue to gravitate up the cap spectrum. One of our preferred plays within the sector has been and continues to be the Asset Managers, as this group steadily climbs the wall of worry surrounding active management. Breadth is healthy, with a plethora of bullish trends - BLK, TROW, EV, AMG, LM, BEN, WDR, PZN, VRTS, APAM, IVZ, OMAM.
Given the bullish trends that markets are exhibiting globally, the recent price action of the European banks (SX7P Index) is worth mentioning, and not in a good way. Unlike the absolute strength being displayed in the U.S., European banks are beginning to act quite heavy. The good news is that credit isn’t an issue, but when groups begin to violate absolute and relative uptrends (see chart below), it certainly grabs our attention. Approaching its respective 200-day moving average for only the second time in the past year, some much needed momentum would be a welcomed development for the fatigued index. While not to the same extent, we are beginning to see some early signs of growing risk aversion among U.S. banks as well, where small caps are starting to diverge on a relative basis versus their large-cap brethren. The same can be said of the group on an absolute basis, where despite the broader sector’s fresh highs on an almost daily basis, small caps banks have been unable to eclipse their early March high. Not necessarily an outright bearish message, but it does help to reinforce our long-held view that there are better opportunities elsewhere within the sector, asset managers in particular.
Soundly responding to last month’s oversold condition, Financials finally broke out of their 9-month consolidation. While it’s hard to argue with this recent acceleration, it’s worth noting that relative performance didn’t confirm the absolute highs. More importantly, has been the diverging relative performance of the banks. Given the extremely bullish sentiment around this group on the prospects of higher rates, the lagging relative performance speaks to the more compelling opportunities that exist elsewhere throughout the sector.
As the broader sector works off the excesses that had developed around resistance, and banks struggle with the reversal in yields, a handful of industry groups continue to impress. Capital Markets, led by Asset Managers & Custody Banks, Exchanges, Financial Data and Online Brokers possess some of the strongest trends in the sector today, and we highlight a bunch of our favorite names within each in today’s report. We remain particularly intrigued with the asset managers, where despite the secular concerns around their business, the equities continue to trace out longer-term bases. We view the recent post-earnings consolidation as an opportunity to build exposure in one of our favorite contrarian plays in the market today. On the flip-side, regional banks (KRE) continue to unwind the post-election euphoria, and look increasingly vulnerable as they struggle beneath the 200-day moving average. Needless to say, the clock is ticking for momentum to present itself.
Coming into the year, I cannot recall a more universally loved sector than the financials, particularly the banks. After years of lackluster returns, investors were once again convinced that rates were heading higher, and with them the broader sector. From a sentiment perspective, the dominant driver behind their performance remains the direction of yields, which is why the current inability of yields to establish upward momentum at support is becoming increasingly maddening. While frustrated that the most recent oversold rally quickly became overbought at a lower high, we take comfort with the fact that spreads remain tight, suggesting that the sector’s broader struggles are one based predominantly on sentiment around yields, and not one of growing credit risk. That said, from a purely technical perspective, yields look like they want to head lower, not higher, strengthening an already stiff headwind for the sector.
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