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Financials breakdown serving as temporary headwind for Equity rally

June 13, 2016


2080-3, 2075-6, 2039-40, 2022-4        Support
2105-6, 2111-2, 2123-5, 2135              Resistance

Key Takeaways

1) S&P trend failed to maintain its gains by end of week, as the move to nine-month highs reversed to close down back into the previous consolidation range.  Technically I don't view this as all that big of a negative since SPX failed to even breach the prior week's lows.  While some partial follow-through might happen Monday and/or into Tuesday, the positives of momentum and breadth should help equities trade higher in the weeks ahead.

2) US Dollar index rallied on both Thursday and Friday of last week resulting in a stalling out in Commodities just as indices had reached levels hit last June/July (CCI index)  WTI Crude oil fell down to test an area near its two-month trendline, and some minor signs of exhaustion happened within the Grains complex.  

3) US 10 and 30-yr Treasury yields broke lows of their consolidation mirroring movement seen in Japan, Germany and the UK where rates have fallen to near 0 and in some cases Negative territory.   While some daily counter-trend signals are in place now which could limit declines in yield much more in the near-term, TNX will require a move back above 1.70% to get back into its prior range before thinking that this decline is complete. 

4)  Sector-wise, Financials weakened substantially in the last couple weeks on yields pulling back and still look to weaken more in the short-run this week.  Much of this sectors ability to rally will depend on long rates likely turning back higher, which for now, still looks premature.  Utilities have managed to prosper under this yield decline, and remain the best performing sector YTD along with over the last 12 months.   While Tech and Healthcare have both shown above-average strength in the last month, last week's pullback favored the defensive sectors which all turned in better than average relative strength.

5)  Similar to SPX, Junk bond ETF JNK moved to the highest levels of the year last week, before pulling back into Friday's close, and its strength is one of the main reasons to continue favoring equities as this typically tends to turn down ahead of the equity market.  Technically, this still looks apt to rise to above $36 to potentially $36.50 which would be an important area to consider fading this move.  For now, no evidence of JNK having made a meaningful downturn.

S&P 500

Short-term Thoughts (3-5 days) : Bullish-  S&P can't be avoided or faded based on one day's decline, and breadth and momentum are strong enough to still favor indices pushing higher.  However, Treasury yields and USDJPY are key areas which likely need to stabilize and in turn can help Financials also turn higher, which would be important given their representation within SPX.  For now, technically it looks likely that other groups can take Financials place. This week, it should be wise to use any minor drawdowns to buy, expecting an upcoming move back to new high territory.

Intermediate-term Thoughts (2-3 months): Bullish-  (No change) - A move back to new high territory is expected before indices turn down to begin any larger correction.  The uptick in bearish sentiment given that indices are within 3.7% of all-time highs looks to be an important factor arguing that further selloffs could prove muted for the time being.  From a fundamental and macro standpoint, factors like ongoing revenue concerns, FOMC uncertainty, China & Emerging market growth, along with Election year angst have all served to fuel bearish sentiment steadily.  Meanwhile technically, despite the short term churning, there remains precious little to be all that concerned about given the medium-term picture.  The A/D-Advance/Decline for the NYSEhas recently moved back to new all-time high territory while weekly momentum remains bullish.   The 5-day Put/call ratio meanwhile has hit the highest levels since mid-February while AAII polls show a greater number of Bears than Bulls for the second straight week.  In addition, the total Put/call ratio has hit the highest level in over three months.  Sector-wise, the start of Technology outperformance in the last week could be telling, as the NASDAQ has begun to act a bit better after a lackluster few months.  While this six-month period remains seasonally weak and daily and monthly MACD are negative, gains should be able to hold indices up into late August before any pullback into the end of Q3. 

Technical review and What to expect

US Equities fell the most in three weeks last Friday, erasing the breakout attempt on a weekly close, which was set to finish at the highest levels since last July for SPX.   While many attributed the selloff to BREXIT concerns, or anemic global growth, the rapid acceleration in Treasuries looked to be a real concern, as Japanese, UK and German Bund yields fell to record lows.  US 10-year Treasury yields meanwhile fell to the lowest levels since 2013 on a closing basis, with most recognizing the Fed's dilemma of trying to hike rates in the US while global sovereign yields are plummeting. 

Overall though, trends remain positive, and it's still tough to make much of any real selling in US Equities, with indices still just fractionally below all-time high territory while breadth and momentum remain in good shape.   Technically speaking, the combination of 1) Decent breadth (with the Advance/Decline having moved back to new all-time high territory and sector of the year)  along with 2) Bullish sector rotation (Tech, Healthcare strength over last month)  and arguably 3) Negative sentiment ,remain key positives to support indices moving back to new high territory into July. 4) Small-caps seem to have returned with a vengeance, and very good outperformance in the last few weeks, while the Mid-Cap index is now pressing up near former highs. 5) High Yield strength-  This was thought originally to be a concern when Junk bonds began to turn lower last year while Equities eventually followed.  Since February though, JNK has rallied to the highest levels of the year and still hasn't shown any sign of peaking.   A sixth reason would involve momentum and structure still very supportive of rallies, as daily and weekly MACD are positive while pattern-wise ( the rally from February moved up far too high to be a counter-trend bear rally. )  Negatives involve 1) the divergence among indices right now (the NY Composite and Russell 2000 managed to move above April highs while the NDX has not)  while 2) Seasonality- indices remain in a tough period from a seasonal perspective (Week after June Triple-Witching has seen DJIA lower the last 22 of 25 years (Starts on June 20 through June 24) 3) Financial underperformance with yields accelerating lower which has coincided with lagging in the Financial space (2nd largest SPX sector, so lagging here is thought to be a definite headwind for SPX gains.  4) Bond yields moving down at an alarming rate, as 10yr yield hit the lowest levels since 2013 while many in Europe and Asia are hitting record lows and going negative.  5) Earnings growth and Economic strength- Both seem to be lagging a bit and these along with Election uncertainty is a big drag on conviction(Negative, though does play a part of a positive factor from a contrarian view.

This week's Weekly will concentrate specifically on the Financial sector, an area that many believe truly HAS to work if equities are going to move back to new highs.  Last week's -1.55% made Financials the worst performing sector of the major 10 for the week and it lags all other sectors in month-to-date performance and for the year, with returns of -3.21%, the only negative sector for 2016, outside of Healthcare, which is just down a fractional 0.75%. 

Technically speaking this sector remains short-term negative after the break of two-month trendline support for XLF while relatively speaking, Financials stalled out at a key area of resistance vs the SPX into late May and turned back lower.  The intermediate-term trend has been neutral for the last few years before January's break of support and this group still doesn't look likely to show a major rally anytime soon, until/unless Treasury yields can stabilize and turn back higher quickly.  Technically it is possible that other sectors can step in and lead the market higher despite Financials underperformance, but there remains a definite headwind when this group is trading in bearish fashion like it's done since late May. 

Charts and comments below.


Charts & Writeups- Financials Sector- Absolute, Relative charts of Financials, along with key sector stocks


Financials SPDR ETF-  XLF- Financials have broken down in the last couple weeks given the acceleration lower in yields, and last Friday cracked the two-month uptrend from April lows.  Additional weakness looks likely over the next couple days, with targets near May lows just under $22.80 before any real stabilization.  As the daily chart shows above, the larger trend has been negative since the middle part of 2015 with a series of lower highs, most recently in late May, which peaked right near important resistance at $24.  This area will need to be surpassed on an absolute basis to argue for meaningful strength out of this sector, and for now, the trend is mildly bearish near-term.


Financials, Relatively speaking v SPX-   This chart of Guggenheim's Equal-weight Financials ETF vs SPX shows the breakdown in this sector which occurred into January of this year while the snapback failed to move high enough to allow for meaningful improvement.  For now, this bounce from January/February lows looks to have peaked at the exact area it needed to hold to maintain a bearish stance on the sector. Moving back up into this range would make the sector more attractive, but likely depends on long rates moving higher.


Equal-weighted Financials RGF vs the XLF-   Ratio chart of Equal-weighted Financials to the popular S&P SPDR ETF XLF shows how the broader Financial sector has made headway of late vs the XLF which is dominated by JPM, WFC, and BRK/B.  This ratio has now reached the highest levels since 2012, showing a far different picture on an equal-weighted basis than what might be just seen when looking at the large-cap dominated ETF. 



US 10-Year Treasury Note Yield- Yields have broken down under this descending triangle formation in place since March, with the 10-year yield having closed on Friday at the lowest levels since 2013   Yields have largely diverged from stocks in the last couple months and have traded range-bound until the breakdown late last week.  The area near 1.70% will continue to be important for yields and counter-trend signals are now in place that could allow for a bounce in the next 2-3 days to unfold.  Until 1.70% is exceeded again, the near-term trend for TNX is bearish and Financials should underperform with targets near 1.60%.



Treasury yields vs SPX- Overlay- The ratio chart between TNX and SPX is shown above, with equities largely diverging from yields for the first time since mid-2015.  For now, there's no saying that equities need to immediately pullback and join yields at low levels, and we should be close to a time when yields can bottom and turn back higher which would give equities a bit of a boost.



KRE- Regional Banking ETF -  Unlike the XLF, Regional Banking ETF KRE has held its trend from early this year, trending higher with no meaningful breaks.  Similar to the Financial space as a whole, however, KRE has shown largely very little evidence of any real strength over the last couple years and remains trending sideways since the latter part of 2013.  Until/unless $39 is broken on a daily or more importantly weekly close, it should pay to stay bullish expecting another push higher as part of this trend.   



KBE vs KRE - The Banking ETF KBE which includes both Commercial and Regional banks, has been trending lower vs KRE since 2013, showing the degree to which stocks like BAC, C have been a weight on this sector, and why Regionals generally have outperformed the broader space.  Just in the last week we've seen a breakdown of last year's lows, bringing this ratio down to the lowest since 2012.   While we could stabilize down near 2012 lows, we'd need to see some evidence of this turning up to think that KBE would begin to outperform KRE, which could take the form of KRE breaking $39.  For now, KRE is preferred within Financials.



Visa (V- $80.18)  Visa remains one of the stronger stocks within the entire Financials space technically.   Its consistent outperformance only temporarily suffered some weakness into early this year structurally, but the subsequent rebound has helped V recapture its former high from late 2015 and after a brief consolidation,  prices lie within striking distance again of all-time high territory.  Movement back over $82 should allow for a quick move up to near $90.  The uptrend from early this year intersects near $78 and should be an attractive area to buy Visa on any further weakness.



JP Morgan (JPM- $63.84) Similar to XLF, JPM has had a pattern of several lower highs, with the most recent happening into late May.  The uptrend from February remains intact, however, and should provide strong support on further weakness, right near $62.50.  Given that XLF has broken down, while JPM remains above, this remains in better technical position to consider buying dips than XLF, and key levels lie near 62.50 on the downside and then recent May highs near $67 for resistance.  Above May highs allowsfor additional follow-through which should test all-time highs just over $70.  Bottom line, weakness over the next 2-3 days should find firm support just above $62 and is likely buyable, technically for a move back to highs.



Goldman Sachs (GS- $149.89) Bearish, and the move down to new multi-day lows last Friday likely allows for additional weakness down to near $140 in the days ahead.  Last year's breakdown, shown on daily charts, was important given the length of time without any material weakness and now bounces in the last month look to have failed at levels below 2015 lows.  This keeps this downtrend intact.  Thus far, the pattern from 2015 has taken the form of three waves down, so a move back to new lows under $140 would represent the first impulsive "FIVE WAVES DOWN" for at least the last eight years. 



Bank of America (BAC- $13.83) BAC remains very similar to the broader Financial sector pattern, with a lengthy period of consolidation which gave way to a breakdown early this year.  The subsequent rally looks to have held where it needed to, and is truly a strong area of resistance for BAC and for the Financial sector as a whole.   In the case of BAC, this lies just above $15 and important to get above to allow for this stock to begin trending higher, with the most important level found just over $18 for intermediate-term purposes. For now, the intermediate-term picture will remain negative until BAC can reclaim this area of its prior breakdown.




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