Broadening out of market at new highs will be important

Divergence between the top performing stocks within Technology and the broader market grew ever more extreme this past week.  However, this doesn’t necessarily imply a large selloff is imminent.  A broadening out in performance can also happen to allow sectors to play catchup to recent large-cap Technology performance, and this seems to have started with Healthcare and Financials in recent weeks.  Near-term, some negative breadth and momentum divergences likely could prove problematic in mid-February.  Yet, there’s been no evidence of any price weakness in the larger indices yet to warrant concern just yet.  As discussed a few days ago, the extent of the decoupling of Treasuries and Equities looks to be continuing.  Overall, keeping a close eye on market internals will continue to be important in the seasonally difficult month of February.

Friday proved to be one of those rare occasions where market breadth finished negative despite SPX and QQQ rallying (yet again) back to record highs, thanks to gains of more than 20% out of META 0.27% .   This represents the 4^th straight week of gains for SPX.

Nasdaq finished Friday up +1.69% and SPX managed to log gains by more than +1.0%.  However, the Equal-weighted Financials ETF (RSP 0.04% ) was down on the day.  Declining issues outpaced Advancing issues by more than a 2/1 margin, and volume finished around 3/2 negative. 

Breadth improved towards the close on Friday from earlier poor levels, but there were still 8 sectors down on the day and just three positive:  Financials, Industrials, and Technology.

Overall, as has been discussed following the Equal-weighted SPX’s negative January vs. a +1.5% positive January in SPX, this divergence does not imply that a major market decline is imminent.  However, it will be important to see a broad-based rally start to develop, given that momentum and breadth indicators have not instilled too much confidence with SPX just below 5000.

Bottom line, if one cannot find technical or fundamental reasons to argue that META 0.27% , NVDA 6.25% , MSFT 1.80%  require consolidation, then attempting to take profits and sell out of this market might not make sense.  However, all of these have risk/reward profiles that have gotten worse on a 2-3 month basis, despite their recent stellar gains in recent weeks. 

Institutional data on Equity outflows showed that the week ending 1/26/24 produced the highest S&P outflows in over five years as Institutions clamored to take profits ahead of “Magnificent 7” earnings.  Judging by this past week’s price results, this rush to the exits likely was a mistake.

As shown below, SPX’s Relative strength index (RSI) is lower than the prior week, not dissimilar from December 2023, or July 2023.  MACD is also trending at lower levels.  SPX appears to have carved out five waves higher from early January 2024.  Overall though, it’s proper to await evidence of market weakness before acting on any of these warnings.  For SPX, that level has risen to 4845, the area near this past Wednesday’s lows.  On the upside, I continue to feel that 4965-4995 area might have some importance.  However, at the present, trends remain bullish, and most passive investors have likely enjoyed a far better year thus far than any involved in active management.

Technology at new highs shows how lopsided, uneven market breadth might be possible temporarily  This sector ratio chart of Equal-weighted Technology vs. Equal-weighted S&P 500 simply shows “Tech” having pushed back to new highs in the last month.

Similar to SPX and QQQ, trying to find fault with price action following a move to new highs is typically quite difficult.  However,  the fact that Tech has advanced to new highs relative to the market while most other sectors have not directly explains why some lopsided breadth figures and distortion might be possible.   Overall though, given that Tech remains the highest weighted sector within 27%, seeing relative outperformance in the markets leading group is certainly not a negative, technically speaking.

Financials sector deserves a tactical Overweight through Summer

Equal-weighted Financials has now returned over 18% over the past three months in absolute performance, based on Invesco’s Equal-weighted Financials ETF (RSPF -0.44% ).

This has outperformed the Equal-weighted S&P 500 along with the actual cap-weighted SPX performance of +14.84%.

Weekly ratio charts of Equal-weighted Financials to Equal-weighted SPX still show the potential for outperformance in the months to come.

DeMark indicators on monthly charts seem to indicate the potential for another four-to-five months of outperformance might be possible before this sector starts to stall out.

While the credit card companies, Insurance, along with Investment and money center banks have proven to be better technical choices than Regional Banks, I expect further gains out of Financials as the US Stock market broadens out.

While this won’t prove to be a straight line, in all likelihood, I’ll join Tom Lee in endorsing Financials as an Overweight at present.  However, I suspect this will change following any rally into July/August timeframe.

Relative charts of Financials vs. SPX still show a rather challenging intermediate-term picture for Financials that is more neutral and range-bound than bullish.  However, I do feel that the recent upward thrust in momentum in this group can carry it higher into Summer 2024.

February likely could show weakness in the back half of the month

Election year seasonality proved to be fairly accurate last month in January, which makes a study of how the average election year February typically plays out.

As this composite (which tracks SPX Election year February’s going back since 1950) shows, the bias tends to be initially down for February before a bottoming out near day 5 of the month.

Then a rally into the 13^th trading day looks possible before late month consolidation.

I suspect that any minor backing and filling of our own gains given the recent negative breadth readings might prove temporary initially.

Thereafter, a sharp rally into the US Presidents Day Holiday might commence before weakening prices into end of month and/or March.