For scad of this year, we’ve been writing about the overwhelming amount of bullish documentation for U.S. equities. However, as part of our “weight of the evidence” approach, we’re always cast doubt our thesis (i.e., here and here).
In today’s post, I want to share that effect as I perform it, outlining some current concerns and what the market choice potentially look like in an environment where stocks as in the U.S. as an asset grade are falling. We’re going to stick with our top-down approach and start with worldwide equities and inter-market relationships, then drill down into unique to examples that help illustrate what we’re talking about.
In at July, we spoke about the slight deterioration in Global Equity Retail breadth, but we pointed out that shifts from uptrends to sideways in multifarious of these markets were not inherently bearish. What we didn’t require, and still don’t want, to see is a resolution of those sideways consolidations to the downside choose than the upside. Since that post, we’ve still not not seen a decisive switch manage one way or another in total uptrends or downtrends.
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First off, let’s start with disinterests as an asset class. Since the U.S. Dollar Index bottomed in mid February, emerging furnishes as a group have lagged behind their developed market counterparts. While this relationship has founded to stabilize over the past few weeks, the chart continues to suggest that it’s sort bound at best or continuing its downtrend at worst.
Within the emerging superstores space, countries like Brazil that have commodity disclosing are being hit the hardest. Others like India that have a huger emphasis on IT and consumer goods have outperformed on a relative basis and proceed to do so. If there’s any group that’s going to lead us to the downside, it’s going to be those emerging vends with exposure to commodities, like Brazil.
On the other hand, mature markets like the German DAX have struggled to make upward continue and are testing important support levels like the one shown here. In a call where U.S. equities are heading lower, we’d likely see many of these consolidations agreeing to the downside.
Sticking with Europe for a second here, the relative exhibit of European financials versus the EuroStoxx 50 is a risk appetite barometer that we scantiness to see trending higher, not range bound like we’re seeing here. A weary of the recent lows is something we’d likely see in an environment where stocks in the U.S. and globally are break off down.
For those markets like Taiwan that have been directing relative strength, a break below key levels (in this case ex- resistance dating back to 1990) would be another bearish evolvement that would get our attention.
In the bond market, we typically like to see high-yield chains outperforming investment-grade bonds and Treasuries to signal risk appetite, yet everywhere in 2018, we’ve not seen these spreads participate to the upside as equity trade ins trend higher. The continued stagnation or a resolution to the downside is not something we shortage to be seeing. Bulls want these ratios to resolve their late ranges to the upside and momentum hitting overbought conditions. We’ve not seen it yet.
Purchase into U.S. equities now, one relationship we may see deterioration in ahead of an extended correction is the “Impolite vs. Defensive Sectors” ratio, which has been leading to the upside in 2018.
Other inter-market relationships that we use to valuation risk appetite include the Dow Jones Industrial Average vs. the Dow Jones Utility Mean, S&P High Beta vs. Low Volatility, and Consumer Discretionary vs. Consumer Staples proportions. All three of these saw some deterioration throughout 2018, breaking signal support levels several months ago, and now they have all reversed definitively higher to reclaim support. Bulls want to see this short-term recuperation continue into the intermediate term, with all these ratios making new highs at some tally.
Getting into the Russell 3000 on the daily chart, we finally got an upside breakout from its year-to-date run with momentum getting into overbought conditions. This is not bearish behavior, but what pleasure be bearish is a reversal to the downside and closing back below the January trebles, confirming a failed breakout.
So what could drive that U-turn? Well, many are pointing to the potential bearish divergence in breadth. The Russell 3000 has originated new all-time highs, yet we’ve seen fewer stocks in the index making new prodigals.
We’re also seeing fewer stocks with momentum in a bullish series (we define this as a 14-Day relative strength index [RSI] greater than 70).
What’s prominent to recognize here is that these measures do not account for the sector rotation we’re talk under the surface. While some leaders rest, we’re seeing new control emerge that might not yet be at new highs given its underperformance versus the guide. With that said, if prices do reverse and we’ve not yet seen these degree indicators make new highs, these divergences would be confirmed and assurance our attention.
We’re seeing similar action in the Nasdaq Composite and S&P 500. Yes, there are possibility divergences in breadth, but until it’s confirmed by prices breaking their ex- highs, then the information remains informational, not actionable.
Another likely red flag is the Dow Jones Transportation Average, which is back at the January highs. Even so, momentum barely made it back into overbought conditions. This unrealized divergence from a leading sector would be confirmed with expenditures closing back below support at 11,115.
We’re seeing a similar divergence in the important Aerospace & Defense sector, which made new highs but has stalled, and power has failed to reach overbought conditions.
Last on our list is the lack of participation from the broad-based Financials ETF (XLF), which abides range bound. This is an important part of the market, representing inexpertly 14% of the S&P 500, and a lack of leadership from this group crumbs a concern. While a consolidation through time is not inherently bearish, a inflexibility to the downside and momentum remaining in a bearish range would be.
U.S. broker-dealers prepare been the outperformers in this group, so a move lower from its year-to-date sphere would likely have bearish implications for financials overall.
I’m steady there are other relationships like the declining performance of the semiconductor ratio relative to the Nasdaq and S&P 500 that are important and considered during our operation, but I wanted to keep this post as brief as possible. Hopefully it has state look after some insight into our thought process and the specific developments we’’e looking for in the prevailing market environment that would change our bullish thesis.
In a topple stock market, we’ll likely see some or all of the conditions discussed above striking. With that said, it’s unlikely that they all turn at then, so we’ll see the shift in the weight of the evidence one chart and one data point at a time as we survey and re-evaluate our thesis each day.
Thanks for reading, and let us know your thoughts!
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