Macro Relative Strength
What a week! The equity markets saw their worst returns in history for the 1st week of a year which was not at all what I expected after last week’s modest improvement in the Intermarket RS structure. That modest improvement was quickly eliminated with the hard drop in equities this week. At this point, we start week 2 with all of the equity proxies in the bottom half of the list except the $QQQ which closed right in the middle spot, but after leading for the last month, that is not promising. The only green we saw this week screamed of the flight to safety which is to be expected when equity markets have such a dismal week. The Size and Style is lining up more from large to small at this point, but $QQQ remained on top showing large growth was still our leader even after a 7% drop this week. There was really no place to hide this week in the broad indexes. It felt like straight liquidation from start to finish with some potential capitulation-like action as the markets slid into the close on Friday after holding up early and then seeing over $2 billion to sell on the MOC (market on close) as we finished. It seemed no one wanted to hold anything into the weekend as panic set in. That said, I do believe it brought us closer to a tradeable bottom for now, but don’t necessarily expect us to start next week with that. With many of the Major indexes sitting at critical levels, it is hard to know when buyers will actually show up. Remember, it is only the first week of the year and it always feels the worst near bottoms. The problem is determining whether the near term bottom will be just a flash in the pan or will build into something more constructive with all the damage done in recent weeks. The longer term investor you are, the more patient you should be here and make buyers prove their conviction. Only the most nimble should allocate more aggressively once we see some buyers show up. Their vacation should be over sometime soon, but whether they come back with a hangover or not is still to be seen.
Sector Relative Strength Rankings
First, I look at the Custom Indexes that I use for all the breadth work to see what they are telling us on a price weighted basis.
Next, I look at a Broad Sector ETF Proxy which I use Vanguard ETFs to make sure things are similar and for some tradeable ideas. Below that is the Equal Weighted version for comparison.
This will differ a little due to the different make-up of the Capitalization Weighted ETFs. If you click on the table (or here), it will take you to a page that will go much deeper into the Sector ETF Relative Strength.
The sector world this week firmly reflected the defensive tone as well with Utilities being the only sector losing less than 1% and the rest of the defensive sectors showing relative strength while still being down over 2%. The only green anywhere in the tables above were in the Precious Metals space which has been one of the most hated over the last couple of years. Moving all the way out to the monthly performance, we only see Precious Metals, Utilities and Real Estate still holding up positive and even then you have to be in the right spots inside those sectors. Once we do start seeing some bounces, offensive high beta sectors should see the most reversion, but may not this time if we are starting a new full fledged bear market. I believe buyers are likely to start to show up soon and we will get a fairly sharp snap back up to the prior support levels which should now act as resistance; however, if we can’t muster a bounce in the near term in key sectors, it will paint a much more ominous picture for at least the next few months and warrant remaining cautious until things do start to improve. Markets do go up and down, so if you are still fully invested, use these bounces to adjust your risk to better match the market action and your outlook as the scenarios begin to play out. The defensive sectors are where we have seen the best action recently and can continue to be actionable if markets remain weak, but in order to see more broad market improvement, we must see the heavy weights like Financials and Technology find buyers sooner than later. The question is what will the catalyst be that can cause such a change? The only two I see right here are earnings season which will start this week and oversold breadth washouts which we will look closer at below.
Broad Market Breadth
Universe of 3,300+ stocks from 10 custom broad sectors and 49 subsectors. Universe contains only stocks (that are both optionable and shortable) with no Preferred stocks, CEFs, ETFs, or UITs to skew the breadth measurements. There is a breakdown of the universe in the powerpoint presentation link at the top.
Last week, I was lulled into believing the lack of negative action might turn into a positive to start the year. I was wrong and the opposite happened. The markets fell hard and sent the breadth readings into a steep decline. Below we see how the week ended.
- NHNL has not made new lows as compared to August lows while price did close lower. Only a potential positive divergence for now, but only if we find our lows before this indicator expands down any further.
- McClellan Oscillator & Breadth Thrust Indicator are both very oversold and likely nearing a bounce zone.
- Moving Average Breadth all fell below 20% this week which is firmly in zones to look for a bottom, but do have timeframe attached.
- Thursday was an 80% down day (with percent decliners at 91.62% and down volume percent at 89.44%) near previous support which should provide a bounce within 1-3 days unless we start seeing clustering signals down here which is more negative.
- Price Trend is turning down on a longer term view with a more significant new low below the September floor.
- Advance Decline Line made new lows for the move with price.
- McClellan Summation Index gave another sell signal below zero.
- While firmly oversold, all the short and intermediate term indicators still have room to move lower if sellers keep the pressure on.
- Even if we do see momentum lows soon, we do need to keep an eye open for further price lows and potential divergences in the indicators before a final floor is found.
All of the above indicators reflected the bearish action this week sending them to the lowest levels we have seen since August-September when we saw a bottom for 2015. Now we are seeing price take out those lows with the indicators heading down fast, but actually not making new lows yet. This could forge longer term divergences, but we are not there yet and shouldn’t count on them. Instead, we recognize both the negative action we are seeing and the potential to forge a bottom with the readings we are now sitting on. This forces us to remain cautious longer term while looking for a shorter term bounce to gauge if any risk appetite can be mustered up at these levels. We are down here now, so instead of panicking, we should keep an open mind and do our best to read the action as it unfolds in the coming weeks.
Broad Sector Breadth
This can give us a first level view of the flow within the broader market. It is a true measure of the markets’ breadth.
After seeing all the McClellan Summation Indexes remain positive, the only one left standing this week was the Utility sector and not by much. That really was the only place to hide. At this point, all of the Breadth Thrust Indicators are firmly oversold with more than half at or below the lower threshold. This suggests some reversion is likely very soon. I find it interesting the only Breadth Thrust that was pointing higher Friday was actually Energy. It may not be first thing as we open on Monday, but I expect to start seeing some improvement in the coming week based on these washed out indicators which can be measured to get some clues as to how far we might expect a bounce to go or how much more weakness we could expect to see in the coming months.
Don’t forget the Breadth Compilation Charts allow you to view all the relevant breadth indicators on one chart for each sector as well as the entire universe. One thing to look for is when breadth extremes line up in multiple indicators on a chart.
Final Note: After such a disappointing December, I was expecting a better start to the year and we didn’t get that. While this builds fear of something worse in the offing (which we need be open to), we have moved so far so fast I do expect some relief soon that can lift markets to higher levels that should be a better place to make longer term adjustments to portfolios. I believe the best scenario might be to start the week down testing or penetrating those critical levels I mentioned above and then seeing some buyers show up to push us back above these critical points forming a false breakdown and potentially generate a hard squeeze to eliminate the oversold state we will enter the week in. From my experience, most of the signs are there for a reversion move. Fear is high, sentiment is in the toilet and the price and breadth action is stretched to the downside. If no buyers show up, I will be more convinced a new bear market has actually started and a whole different game plan is in order for both longer term and tactical investors. Either way, it is probably worth moving a little more tactical for now while we are figuring it out.
Have a great week!
G. Thomas Lackey Jr, CMT CFP® CFS
The information set forth herein was obtained from sources which we believe to be reliable, but we do not guarantee its accuracy. Neither the information, nor any opinion expressed, constitutes a solicitation by us of the purchase or sale of any securities or commodities. There is no guarantee that the views expressed in this communication will become reality. Investing in the stock or bond markets involves risk and potential loss of principal. Investment strategies should be thoroughly vetted and discussed with a financial advisor prior to implementing.