Defensive groups not offering much Safety as stocks and bond yields break down in tandem
- SPX pullback happened on above-average downside volume and a breakdown in rates
- Treasury yields likely weaken further and cycles point to late January, then March for low
- Defensive sectors like Staples look quite negative after Wednesday’s break of support
Over the last few days it’s been discussed how markets were nearing resistance. Yet, is it correct to think that “bad news” was truly bad news for stocks if rates are breaking down? It’s been difficult to fight the trend of falling yields being good for Equities, and one day of divergence is hardly enough to think this trend is breaking down.
Additionally, Defensive sectors like Consumer Staples and Utilities lagged all other sectors in Wednesday’s trading. It’s been difficult to have conviction that stocks might be ready to weaken if/when Staples hits new multi-week lows coinciding with rates also weakening further.
Importantly, despite breadth not disappointing too meaningfully, volume was very heavy in downside issues, resulting in an Arms index (TRIN) reading above 2.0. Normally readings like these which happen following a multi-day or multi-week rally are more negative, than when they happen following a lengthy decline when they’re more apt to signal downside capitulation/exhaustion.
Overall, I suspect that SPX should be in the process of rolling over into next week which would align with cyclical weakness extending into end of January. However, it’s thought that SPX-3900 might hold initially and allow for a bounce before a further drawdown gets underway. (Only if 3764 is violated can we believe that this weakness could get more extreme and is not buyable)
Bottom line, one cannot rule out a snapback to test this week’s highs in Equities into Thursday/Friday. Near-term support seems to come in near 3892-3900 and could provide some support to this pullback. Any ability to undercut 3860 would argue for a complete retracement of December lows, which seems a bit early to call for given the sector rotation underway.
Treasury yields break down to multi-month lows
Rates have broken support as of Wednesday’s close when eyeing the 2-year, 5-year and also 10-Year yields.
This does not look immediately fadeable heading into Thursday but directly goes against the recent correlation patterns having been seen in Equities to Treasuries strengthening and weakening in tandem.
Does one day of divergence suggest that deflation is starting to be priced into earnings, and/or that this correlation will immediately cease to exist? That seems doubtful.
However, no counter-trend buys are present in US 10-Year Treasury yields to suggest a bottom in rates, while the counter-trend TD Sell Setups for QQQ1.75% and SPX were suddenly erased given the degree of weakness in stock indices on Wednesday.
Yields falling further would seem to be a bullish factor for Equities, not bearish. Yet, Wednesday’s support breakdown suggests more weakness in rates is likely.
Defensive groups breaking down sharply
Technically speaking, I discussed that breadth might start to deteriorate into end of week while defensive groups began to strengthen. This normally is one of the hallmarks of a rally which could be vulnerable to failing.
However, despite very heavy volume into down issues, which I see as negative, most of Wednesday’s weakness came from defensive groups like Utilities and Consumer Staples, which normally are not the weakest sectors during 1-1.5% market declines.
Consumer Staples, in particular, has broken support going back over the last few weeks, which is a technical negative. Equal-weighted ETF’s by Invesco for Consumer Staples, RHS, fell to close at the lowest levels since mid-November on Wednesday (1/18/23)
This is a negative, suggesting that either an ABC corrective pullback is underway, or a five-wave decline. Regardless, near-term weakness looks likely in this sector, and should not be bought right away on this weakness. Downside targets could materialize at $165.68, or more likely near $162.76 before this begins to stabilize.
Stocks like HRL0.00% , TAP, MKC0.44% , KHC-0.31% , PG0.75% , KO0.18% , and HSY0.40% made particularly bearish breakdowns that argue for additional weakness. One should consider breaks of support in any UPTICKS Staples holdings like HSY0.40% as being serious support violations which likely don’t’ offer much near-term support given the weakness in the sector.
Treasury yield cycles seem to show weakness into March before a bounce into Fall
Cycle composites of Treasury yields going back more than 30 years seem to focus on several prominent cycles that have been quite accurate over the years.
One of the inputs involves the weekly TNX cycle of 194 weeks, and when combining other cycles with harmonicity to this length, I managed to build a four-cycle composite for Treasury yields. Both daily and weekly cycles peaked out in 2022 and showed weakness into 2023.
Dominant cycle length of 75 weeks turned down recently in early October and stays negative into the last week of January before bouncing.
Yet, most of March seems to have a downward bias before a final low and the start of rates lifting again, which according to Elliott-wave structure, seems to indicate a sharper rally than what markets seem to be pricing in.
At present, weakness into late January is likely and then bounces likely should fail and give way to additional weakness into the middle part of March. If positive correlation trends continue between Equities and Treasuries, this would seem to indicate a far stronger 1st quarter by risk assets than what many strategists are forecasting.
