Despite a fair amount of price volatility over the past 5-weeks, little has occurred to alter our view that technology is in the midst of a typical consolidation following a dramatically overbought condition. We’re constantly on the lookout for divergences, keeping a close eye on semis and small caps for a sign of growing risk aversion, something we have yet to definitively see. The one group that continues to trouble us happens to be Communications Equipment. Absolute trends are finally catching up to what relative strength has been sniffing out, with a growing list of names looking increasingly vulnerable as we head into earnings season.
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Oversold entering Yellen’s testimony yesterday (7/12/17), Utilities and REITs enjoyed her more dovish tone, as rates pulled back near resistance. Any way you slice it, both groups were oversold, but with sentiment around rates a significant driver in the shortterm, now the real work begins. As we have always discussed, how you respond to an oversold environment is critical. In an uptrend , these backdrops should be met with bullish momentum, breadth and relative performance, it’s when these attributes are absent that our concerns begin to grow. Trends would favor utilities over real estate, as select areas such as retail and office continue to languish within REITs.
Of all the charts that I look at weekly, the long-term relative base that the industrials sector has carved out continues to be one of the more interesting setups in the market today. Despite a great amount of volatility over the past decade, industrials have made little headway versus the broader market. However, if our view of the chart below is correct, the sector is setting up for a sustained period of outperformance. Thanks to challenging seasonality, our outlook is not without risk in the near-term, but we remain extremely intrigued with the way the sector sets up from a long-term technical perspective.
As we enter the second most challenging month of the year for small caps, we have to admit that we are impressed with their resilience. While we have seen a modest loss of momentum internally thanks to the rotational nature beneath the surface, equities have generally absorbed the news flow quite well. However, when we take a step back, we continue to believe that more attractive opportunities will present themselves over the summer months. Within the context of an uptrend, a few things continue to temper our near-term enthusiasm. Volatility, even when compared to the past few years, remains at uncomfortably depressed levels, which when combined with the seasonal headwinds and waning momentum leads us to believe that patience is warranted at current levels.
Trying to select the most important charts for the next six-months is always a tricky task, because the market has a funny way of humbling us all. What is most relevant today, becomes an afterthought months down the line. That said, I continue to believe that the direction of yields will lead the way from both a style and sector perspective for equity investors. Admittedly, as of last Monday (7/3/17), yields and the curve looked like they wanted to continue their slow grind lower, but then came the violent counter-trend rallies of the past week, as the reflation trade broadly gained some near-term momentum. This initial acceleration needs to be respected, but I believe that it’s too soon to say that we are once again off to the races. Following sharp moves like the ones we just experienced, the real test is how the underlying assets responds to their first level of resistance and initial overbought conditions. If momentum is able to persist in the face of these headwinds, a regime change is likely underway, if not, look for a resumption of the first half’s playbook. After multiple head fakes over the years, I sure hope it’s the former.
Of all the sectors we have written about over the past few weeks, Consumer Staples has been the biggest challenge. Not from a trend perspective, as relative performance remains in a well defined downtrend, but from an excitement standpoint. Outside of Constellation Brands bullish gap yesterday post-earnings, there just aren’t a lot of actionable ideas on the longside. It’s gotta be a sign, right? The sector tends to do well when risk-aversion creeps in, and given our near-term reservations around equities, the chart below grabbed our attention. Admittedly not a game changer, but from a seasonal perspective relative performance tends to drift higher throughout the 3rd quarter, which ties in quite nicely with our expectation for increased volatility in the months ahead. As the sector once again flirts with long-term support on a relative basis, every little bit helps.
Led by the difficulties within retail, Consumer Discretionary sector remains one of the more treacherous sectors to navigate. The long awaited improvement in relative performance has stalled out once again, as the recent overbought condition came into play at downtrend resistance. Many of the relative issues can be traced back to retail, but media and autos are clearly not helping. On the flip side, there are a number of industries exhibiting bullish price action and trends, with Diversified Consumer Services, Hotels, Restaurants, Household Durables and Internet leading the way. Speaking of Internet, we have received a fair number of questions on whether F.A.N.G. and its two consumer members are buyable on their most recent pullback.. Our sense is that a deeper oversold condition will develop during the 3rd quarter, but as the chart below highlights, AMZN looks to be basing on a relative basis versus NFLX. We ran a similar exercise for GM & F and PHM & CAA in today’s report (6/29/17), along with a look at a handful of names that caught our eye on a multi-year basis.
The unrelenting oversold condition in Energy is a great example of why trying to bottom tick a downtrend can be a particularly frustrating and money losing proposition. With crude finally gaining some near-term traction at support, the question we continue to receive from clients is whether it is time to aggressively take advantage of the equity pullback. Unfortunately, the various pieces of our process tell us it’s too soon. Technically, the stocks and the underlying commodity look like they want to head lower, while cracks are beginning to appear in credit. Refiners continue to be the best bet for relative performance within the sector , but we’ll be the first to admit that the group is in for a sharp reversal if our broader concerns around the sector fail to come to fruition and the oversold condition gains meaningful traction.
Breaking out through heavy 2-year resistance, Health Care has been exhibiting some of the strongest momentum in the market today (6/27/17). With questions and concerns focused elsewhere, the sector has very quietly become the 2nd best performer year to date, and actually eclipses technology if we were to measure on an equal weighted basis (20% vs. 18%). Clearly overbought following the recent acceleration, pullbacks are to be expected and healthy, but given the bullish price action use consolidations to your advantage.
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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