Utilities have been one of the bigger beneficiaries of the growing risk-aversion globally, accelerating to fresh highs. Tactically in the near-term, this recent move has pushed the sector back into overbought territory on a few different metrics (e.g. 1-months highs > 75%, RSI), and suggests that a period of modest consolidation (2-4%) is likely. While I remain encouraged by the uptrend in place, what has really caught my eye, has been the base that the sector has been tracing out over the past year on a relative basis versus the overall market. With the consensus continuing to call for a breakout in rates, one has to wonder what the relative is sniffing out.
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Should we worry about the developing divergence between transports and the broader market? We have received a fair number of questions with regards to this concern, and I want to caution against reading too much into this recent period of underperformance. The main culprit behind the lagging performance has been the airlines, while Air Freight & Logistics, Rails and Trucking remain firmly within their respective uptrends. Airlines responded favorably to their deeply oversold conditions in late August, only to see upward momentum quickly dissipate at resistance. On the verge of oversold once again, failure of sustainable upward momentum to present itself would clearly be an unwelcomed development, providing additional ammo for the bears. Today’s report takes a look at the individual names within the industry, and while some look extremely worrisome, one particular name could be confused for a leadership tech company.
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.
Our view on staples can be summarized pretty succinctly - rich multiples, lackluster growth and challenging technicals. Not an ideal combination. However, it is a relative world, which shines a positive light on select beverages such as KO, BF/B, STZ and SAM. Despite its leadership status and limited breadth, the industry continues to offer a fair amount of relative shorts as well (e.g. PEP, DPS), helping to provide what is developing to be an interesting pair trade – Long KO/Short PEP. As the chart below highlights, KO is consolidating at $47 resistance, but looks poised to take this level out, while PEP is struggling to create any sense of upward momentum at support. The relative performance of KO vs. PEP is breaking out, and looks like it has some room to run.
On the heels of the bullish acceleration that began in late August, small caps were relatively quiet last month, trading in a narrow 2% range, as they slowly worked off the excesses that had developed. Looking out towards year-end, trends remain constructive, a favorable setup that is further bolstered by the historical bullish implications of September’s momentum surge and the start of favorable seasonality.
How any financial asset responds to its respective overbought or oversold condition is always quite telling, especially in the context of their underlying trend. The internal capitulation that energy experienced in later August set the stage for some much needed relief, but how the sector fared when faced with its first overbought condition was the much bigger test in my view. So far, so good, as the broader sector has digested gains with a modest pullback to near-tem support. Energy stocks still have plenty of wood to chop and are far from leadership, but I am encouraged by their recent price action. A view that is bolstered by the improving tends in oil, where Brent broke out and WTI looks like it wants to follow, along with healthy credit markets.
Outside of Managed Care, Providers & Services has been fertile ground for those looking for shorts, particularly the Distributors. Despite the bearish sentiment that is ubiquitous in my discussions with clients, the charts do not suggest that their underperformance is nearing an end . No other industry has a similar breadth of downtrends, with 100% of constituents looking better for sale, and I would use overbougtht conditions as they develop at resistance as an opportunity to unload longs or reengage on the short-side.
Outside of semis ripping and reversing their relative divergence, little has changed from a trend perspective over the past month within the TMT space. Although we continue to see some moderation on an equal weighted basis, outside of communications equipment, tech continues to look solid, media not so much, and telecom even less so. Juniper (JNPR) has been a great example of the technical concerns I have had around comm equipment, and while the bigger picture trends remain worrisome, the oversold condition that developed following last week’s earnings preannouncement likely marks an interim low for the stock. Despite media’s struggles, Comcast (CMCSA) has been one of my favorites, and I have to admit that the past 6-weeks have not been kind to that bullish view. Oversold at longer-term support, failure of momentum to develop would be a victory for the bears and increase the likelihood of the stock seeing the low $30s.
The momentum surge that developed out of the late summer oversold condition has helped to solidify the underlying trend for small caps, and positions them well into year-end. Historically, similar internal accelerations (1-month highs > 50%) have been met with a digestion of gains in the near-term (chart below), before posting healthy gains afterwards. This current consolidation ties in nicely with the seasonal October soft spot, after which performance tailwinds tend to build into year-end.
Entering the thick of earnings season deeply overbought, it’s fair to say the recent lull in volatility is unlikely to last for long at the stock level. The good news is that industrials, along with the broader equity market, possess healthy underlying trends, signs of internal momentum, confirming credit and positive seasonal tailwinds. This backdrop should continue to support leadership trends and we would use volatility around earnings as an opportunity to build positions heading into year-end.
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