In recent days, equity markets, notably smaller-cap and more cyclical indices, surged through important resistance levels that had been in place for over two weeks. This acceleration looks to be part of a bigger internal shift taking hold within equity markets that I would encourage investors to pay close attention to over the coming months through year-end.
Secular growth stocks, notably technology stocks and healthcare have been the two main areas of the market that have outperformed into and off the lows in late March. However, this week saw a significant rotation away from many of the existing growth leaders toward more cyclical groups.
This week’s chart illustrates the ratio between two main market themes represented by Invesco’s high beta ETF (SPHB) and low volatility ETF (SPLV). The high beta group tends to contain more stocks that are cyclical and sensitive to the economy while the low volatility group tends to contain more defensive or safety stocks.
Over the past week, higher beta cyclical stocks, began to accelerate as traders covered shorts and investors began to accumulate deeply oversold groups from banks, to consumer discretionary stocks to airlines and cruise lines while cutting back exposure to utilities, staples and some of the leading FAANG stocks. My expectation is that this rotation is likely to continue but expect the uptrend to be very choppy.
There are two technical developments I would highlight in the chart above. The first is that the rebound from the March lows conveniently developed from exactly at dashed red downtrend line joining the two prior cycle lows in 2011 and 2016. I don’t know for sure what the future holds but my opinion is the March lows define another major cycle low in this relationship.
Secondly, the weekly momentum indicator in the top panel is finally turning up from deeply oversold levels. Normally, this type of momentum upturn suggests further upside over the coming 1-2 quarters. The bottom line is that despite the ominous economic headlines in the media, the market is incrementally beginning to rotate back to many of the deeply oversold, lagging cyclical groups.
Bottom Line: My recommendation is to incrementally increase exposure to some cyclicals in your portfolio.
