Key Takeaways
- Tough to make much of Wednesday’s post-FOMC bounce; sell strength at 3900
- Energy finally rolling over and further consolidation expected
- Utilities and REITS have shown greater than normal weakness, but nearing areas to buy
While expected, SPX’s minor bounce into/post FOMC failed to accomplish too much that would give investors hope that a big rally was underway. Unfortunately, despite the brief reprieve of the selling after five consecutive down days, the Elliott-wave structure seems to paint the last few days as a possible fourth-wave corrective move, as it’s been very choppy and overlapping. Thus, I expect adopting a trading philosophy might make more sense for those short-term oriented vs. expecting any sort of material rally and/or expecting markets to start trending anytime soon. This translates into selling strength like Wednesday while using any weakness back to new lows to buy. Key resistance above 3837 lies at 3900, while under 3875 likely allows for weakness back to test, if not briefly undercut, 3705 in the short run. Happy Trading!
Energy finally showing some consolidation after its steep run-up
The pullback in WTI Crude over the last four of five days suggests Energy is finally beginning to show some weakness, which has been expected, but had not materialized until this week. Both Equal-weighted and Cap-weighted Energy sector ETF’s are down between 9-11% over the rolling five-day period, and I expect this continues into late June/July.
I’m expecting that at least half of May gains are erased for WTI Crude, which could bring prices down to the lower $100’s. Uptrends in both OIH and XOP from May have been violated over the last couple days, and XLE stands to break its two-month uptrend from April lows this week.
As seen below, Crude is also set to break its uptrend, which should drive this down to near $111 initially, but should have a deeper pullback to near 108. Given the ongoing positive intermediate-term momentum, a pullback like this would be a chance to buy Energy.
Utilities along with REITS showing real weakness
Interestingly enough, we’ve begun to see real deterioration in groups like Utilities and REITS despite markets being volatile and not having started any meaningful bounce. Some might blame this on Treasury yields having accelerated in a bit more meaningful fashion as 10 and 30-year yields broke out above 2018 peaks. Furthermore, the rally in real yields has proven robust in recent days, which coincided with declines in not just Defensive groups but areas like precious metals.
In performance data through 6/15, Utilities are set to show weekly declines of nearly -10.64% (RYU- Invesco Equal-weighted Utilities ETF), which turns the 3-month performance negative. In year-to-date terms however, Utilities remain an outperformer to the broader US benchmark averages, and it’s thought that near-term weakness likely represents a buying opportunity.
Reasons to buy dips are threefold. First, defensive sectors like Utilities are likely to outperform as equity markets enter a volatile stretch into end of Q2. Second, US Treasury yields are showing evidence that a cyclical peak could be near (and should be in place by the end of June). Third, as shown below, prices on commonly watched Utility ETFs like RYU or XLU are now nearing key trendline support which has held going back since last summer. This held already twice since the initial trough was formed last July, and points to a decline to $64.42 as providing an excellent entry for longs.
Utilities like ED, DUK, SO, ATO, XEL and ES are preferred to buy technically on this weakness. These have outperformed within the XLU this year and are down anywhere from 13-16% off 52-week highs.
Meanwhile, laggards like AWK, AES, NEE, PNW, FE are all down more than 20% and have broken down to at least new six-month, and in some cases, new annual lows. This area of weakness likely continues, and these would be ones to avoid, not expecting as much of a snapback.
VIX has begun to consolidate in a triangle that’s narrowing
Finally, it’s important to highlight the CBOE Volatility index, or VIX, which many are watching carefully, and note that implied volatility never got back to the key 40 level on VIX into the May bottom.
The “40 level” isn’t important to hit per se to expect that equity markets might bottom. As detailed recently, it’s more about seeing evidence of meaningful backwardation between Spot VIX and 2, 3 month futures contracts.
As investors are aware, VIX normally will decline during market rallies, or sideways consolidations, and even mild orderly market pullbacks. Thus, despite how bad this six-month equity decline feels, the VIX has been far more orderly in its movement than what happened back in January.
To recap, January saw huge outflows and underperformance in large-cap Tech and markets were largely caught off guard. Thus, for those expecting that VIX needs to rise, it’s important that we see larger than anticipated market declines and/or volatility that are unexpected. (And this doesn’t necessarily always have to be in a downtrend; the VIX has gone up sometimes as stocks have risen if volatility is severe enough.)
Bottom line, this daily chart shows the formation of a giant triangle pattern that’s been narrowing. In all likelihood, a consolidation that follows an uptrend manages to resolve itself with an upside breakout. Thus, any move back above this week’s highs of 35.05 will be hugely significant technically, and likely coincide with a possible final equity market washout into late June. Conversely, breaks of 23.74 would be negative for VIX (likely positive for markets) but it will take a violation of 20 to truly believe the equity markets are in the clear. Given the uncertainty ahead of the end of quarter, buying implied volatility on the recent pullback seems prudent and, technically, looking to sell on an upside breakout.
