Despite Legitimate Concerns, Silver Linings are Developing
Investors are understandably worried that equities markets have peaked, and a more serious, prolonged correction is underway. After all, election uncertainties aggravated by rapidly rising COVID-19 cases, a lack of headway regarding federal stimulus and large-cap technology stocks stumbling during this earnings season are just a few issues unnerving investors’ risk appetite. For those that follow technical analysis, the lower S&P 500 high in October versus the September high followed by the break below the 50-day moving average are additional reasons some investors are justifiably nervous.
However, encouraging silver linings are developing – While all of the above are legitimate concerns not to be lightly dismissed, there are a number of technical events I view as encouraging silver linings beginning to develop technically.
First, daily momentum indicators, tracking 2-4 week market swings, are becoming oversold suggesting a tactical low is likely to develop within the coming week as the S&P retests support at the September 24 lows near 3209. My expectation is that this indicator will start to bottom within the coming week setting the stage for another upside rally into Thanksgiving and early December. What levels do I view as important to hold? I view range between the September 24 lows at 3109 and the 200-dma at 3166 to be the key support band that needs to hold in the coming week for my optimistic thesis to remain intact.
Secondly, while the equity markets have been probing new lows into Friday, the VIX volatility index is stalling at the highs of the past three days. Granted it is very early to state conclusively volatility has peaked but the lack of upside follow through is the type of divergence traders would be looking for as early evidence that the VIX is peaking after its recent surge.
Third, and arguably most importantly, US 10- and 30-year interest rates have continued show signs of firming despite the risk off behavior seen in equities. Within the bond market the spread between longer term and shorter-term rates has been widening which is generally considered a bullish signal for the economy and cyclical stocks. In addition, real rates, which is the difference between nominal yields and the inflation rate, is also showing signs of bottoming. Granted, these bond market fluctuations are only short-term divergences at this point, but they are not the type of behavior I would expect if investors were positioning for a more protracted correction in stocks. In fact, the behavior in the bond market suggests to me the sell-off in equities is nearing the latter stages of their recent pullback.
Lastly, within the equity market, cyclicals are incrementally outperforming as large-cap growth and technology stocks pull back from their impressive surges into late August. If the cyclical stocks were leading the broader market to the downside, I would become more concerned about the equity market. However, so far, their improving relative performance versus the S&P 500 suggests participation is beginning to broaden within the equity market.
Figure: Weekly Sector Review
Source: FSInsight, FactSet
- Technology’s relative performance remains above its rising 200-day sma but has broken below its rising 50-dma over the past two weeks and continues to weaken.
- As technology corrects, industrials and materials along with communication services and utilities trend above their 50-day sma’s.
- Financials are showing early signs of improving but have yet to meaningfully reverse their relative downtrend.
Figure: Best and worst performance sectors over past 3 months
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