Regardless of the reason, corrections are never fun, but in my view, the necessary course of action that keeps the market and its participants sensible and sober (although after the past couple of days I’m sure we could all use a drink). After a couple of months of defying the skeptics (myself included), record levels in complacency and ebullience have started to give way to the market’s deepest oversold condition since last summer, as signs begin to appear that a tradable low is near.
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Trend followers by nature, needless to say the past few days have not been kind for momentum, as leadership groups viciously give way to longer-term laggards. One of the more pronounced examples is occurring within the Financials sector, where banks are benefitting relatively from the sharp pullback in FinTech. The question is, is this the start of a new regime of value leadership or just a painful correction within well defined trends? We lean towards the latter. Counter-trend moves are always the most painful, catching both bulls and bears offsides, but as the charts in today’s note reinforce – recent moves have done little to alter the trends in play. How these groups respond to their developing overbought (banks) and oversold (FinTech) conditions will be particularly telling for what awaits into year-end.
We’ve always believed that the beauty of the charts is the objective and unemotional nature that they bring to the investment discussion. We mentioned this, because the internal deterioration that we have observed across the Financials sector over the past month is noteworthy – especially as you work your way down in capitalization. The banks are particularly frustrating, as they have been unable to exhibit any sense of escape velocity out of their lengthy consolidation and remain stuck in the mud at late 2016 price levels.
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.
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.
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