With the market up slightly over the past 12-months, the dramatic outperformance of the bond surrogates is particularly telling as cyclicals continue to struggle. I’ll have more in my weekly video tomorrow but a few charts that caught my eye this morning.
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As the market continues to reward last year’s biggest losers to start the year (a trend which is unlikely to persist), I wanted to flag Chris Senyek’s note from yesterday – “An Extreme ‘Low Quality’ Rally”. Each month, Chris and his team publish Senyek’s Long Stock Screens and Senyek’s Short Stock Screens, featuring their favorite long and short ideas across many investment styles. In January, top performing stock baskets were centered around Low-Quality themes including High Pension Risk, High NOLs, Low Earnings Quality & High Short Interest, Decelerating EPS & Low Free Cash Flow Yield, and High Capex & Low Free Cash Flow Yield.
As the past 6-weeks have proven, counter trend rallies can be painful - especially when coming out of a dramatic oversold condition and a little love from the Fed. With the S&P 500 now a whisper away from its 200-day moving average, the chart below bears close watching. Overbought signals can be a sign of momentum when the underlying asset is trading at fresh highs (early ’17), it’s when they develop at lower highs or beneath resistance that my skepticism grows.
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.
One of the best parts of my job is that I’m able to get a sense of what’s working and what’s not across all asset classes on a global basis. I mention this because in going through a bunch of longer-term charts this weekend, I believe that it’s important to once again highlight the structural damage that has been inflicted on most equity markets around the world. Oversold conditions have been met with lukewarm demand and absent much needed upward momentum. Are U.S. equities setting up to follow a similar pattern? That has not been the case for domestic equities over the past couple of years at the index level, as oversold environments were aggressively pounced upon by the bulls, as they viewed each dip as a buying opportunity.
The hard part with divergences is that they can persist for months before finally resolving themselves, but at some point, these unhealthy underpinnings rise to the surface. It should be of no surprise that the segments of the market that had been sniffing out trouble (Value Line and Russell 2000 indices, cyclical deterioration, semiconductors, banks, biotech) are tactically the most oversold, while the S&P 500 challenges intermediate-term support for the first time since late June. Normally, these developing signals would provide an ‘all-clear’ signal and compelling buying opportunities, but with the S&P off a mere 2% from its respective high, I’d like to see a bit more of a wash out before positioning for the typical seasonal strength of the 4th quarter. Like most, I’ll be keeping a close eye on the bond market as yields have come awfully close to piercing their nearly 40-year downtrend – for what it’s worth, prior challenges have not been welcomed with open arms by risk assets.
l-time highs for the Dow with the S&P on deck and yet I just can’t fully embrace it. Maybe it’s the first chart below, but I think it speaks volumes about the frustration shared by many of the investors I speak with – the continued narrowing of the market. Since the end of August, the S&P is up 1% while the Value Line Index (1700 companies equally weighted) has fallen nearly 2%. If we focus just on the tail of the market – the Russell 2000 is down 4.5% over this timeframe, while mid-caps have gapped to multi-year relative lows. It’s been stealth, but the lack of participation on these new highs should not be ignored…I wish I was that narrow
Back from vacation and if I were to just glance at the price of the S&P – one would think that little has changed over the past week that warrants attention. At the index level, equities have so far bucked the seasonal headwinds and trade within a whisper of all-time highs, but it’s beneath the surface that things become a bit more interesting and quite frankly, leave me scratching my head, looking for additional clarity on what the market is trying to communicate.
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