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Equal-weight Technology dropping to new relative lows could make correction extend

October 8, 2018


S&P 500 Cash Index
2883-5, 2864-5,  2823-35, 2817    Support
2916-7, 2923-5 , 2945-6                Resistance


Summary:  Trends remain near-term bearish in the short run, with US Stock indices having rolled over to violate 4-5 month uptrends as prices finally gave way to join momentum and breadth which had largely peaked out in late August.  Meanwhile the broader intermediate-term uptrends remain very much intact.  Therefore this shakiness which began late last week remains just some seasonal volatility in a month where such volatility happens to be very common, and until larger trends show evidence of giving way, this pullback likely will turn out to be buyable into mid to late October ahead of the mid-term elections.  Meanwhile, Bonds have broken down both domestically and abroad, with US 10-year Treasury yields jumping to the highest levels in more than five years and bond yields exceeding long-term trends going back since the mid-90's.   The Dollar remains choppy, range-bound in recent months, while more positive in the near-term, as prices have carried up to near former highs and stalling.  Additionally, commodities have begun to bottom out, with the Energy rally leading Grains, Softs and precious metals to also begin to lift.  Overall, a market which remains one of many moving pieces but which sector rotation up until last week was able to bail out weakness in Technology and Financials.  The CBOE Volatility index, meanwhile has started to edge higher, and as daily charts below illustrate, last week's close successfully exceeded the entire trend from late June while having shown higher lows in the last couple months.  It's thought that a technical spike to the low 20s is possible in the next couple weeks before volatility starts to compress again, and for now, it's right to own implied volatility, expecting this could lift in the volatile month of October. 


Overview:  Last week finally saw the much anticipated volatility as stock indices fell to match what breadth and momentum had been saying could happen for the past month.  The degree to which bond yields spiked last Thursday seemed to kick off an exodus out of risk assets and both stocks and bonds moved in unison with yields reaching the highest levels seen since 2011.   Most breadth indicators like the Advance/Decline and Summation index, had peaked out in late August and spent much of the last month falling, even as stock indices were working their way higher.   Technology continued to lag with drops in Semiconductor and Hardware names falling, and Discretionary also rolled over with Retailing starting to weaken, along with continued pressure in Homebuilding names.  Even healthcare wasn't spared, with Biotech (XBI) dropping to the lowest levels since May.   However, perhaps the most curious move came out of Financials which failed to keep up with yields, and despite a minor bounce last Thursday, still haven't moved up meaningfully enough to suggest any sort of change in trend.    Overall, given the ongoing negative slope in momentum while breadth has moved to multi-month lows, some time of a correction is overdue and finally looks to be underway.   Ironically, just as August and September dramatically outperformed expectations, turning in good performance in a seasonally weak time, October now looks to have the potential of being much worse than expected just as most have been talking up how bullish Q4 should turn out. 

Bottom line, we'll see the extent to which corrections could prove short-lived and allow for just minimal damage before prices start to stabilize.   At the close last Friday, SPX and NDX had both violated four month uptrends, yet remained above longer-term areas of support drawn arithmetically from late April.  This area should be tested, which intersects near 2823 for SPX, while the larger area of support lies near 2779 which would be a daily 1x1 price/time angle from the February 2016 lows.  Technology has shown evidence of turning lower, and given that NYSE new 52-week lows are spiking to multi-month highs while momentum and breadth are already bearish and dropping, a further pullback in price is expected in the next couple weeks.  If Fear starts to pick up on this decline and we see an outsized amount of volume into declining vs advancing stocks in the near future while prices remain above intermediate-term trendline support, then it should be right to buy dips ahead of the election.  However, if channel support is broken on SPX, DJIA and Nasdaq from late April lows, this could allow for a larger correction to test areas just under 2780 in SPX.   For now, a defensive stance in equities still looks correct.

Bond yields meanwhile look stretched, but should begin at least minimal pullbacks sometime this week which could take yields lower in the near-term after huge spikes.   Thelarger trend however, looks very much negative technically for Treasuries along with UK Gilts after yield breakouts of trends going back at least the last ten years, and in the case of US treasuries, yields accelerating higher in breaking out of 20+ year trend channels.   Meanwhile the US Dollar looks stretched and could begin to pullback in the weeks ahead, particularly vs some of the Emerging market currencies, while commodities look to be starting at least a minor bounce.  It remains right to favor Energy within the commodities space ahead of November, as Crude, Gasoline are showing very good signs of momentumlately and last week's late pullback should be buyable.  At present, Energy still looks more attractive than the metals, but this could show signs of changing by month's end.  Until there's evidence of crude starting to weaken,  this should still be favored above the metals complex for further gains in October.   Additional highlights, summary and charts below.

Recent developments important to highlight heading into this week:
1) Technology sold off to new monthly lows in Equal-weight terms vs SPX, breaking down under Sept lows
2) US Treasuries have started to correlate positively with Equities, with last week's meaningful selloff also coinciding with Equities weakening.  
3) Small-caps and Mid-caps have begun to accelerate lower lately, after both peaked out vs SPX in June.  The last two weeks saw meaningful underperformance
4) Biotech could be a source of near-term weakness within Healthcare after XBI broke down to new multi-week lows last week
5) Energy still favored for outperformance and XLE showed some evidence of playing catchup to both OIH and XOP last week, breaking out relatively vs SPX
8) Europe weakness still underperforming US pullback and should still lag in the next few weeks.  Patterns on SX5E, SXXP, DAX look far worse than US equity indices
9) Breadth and momentum gauges have turned down more sharply and after two late week declines, these haven't given any indication of positive divergence, but have movedlower with price, which is a negative
10) Commodities have been showing strength in the last few weeks, despite a rising Dollar and rising yields.  Energy strength has been followed by Metals, and Softs strength, which would likely accelerate if/when the Dollar turns down.   This should lead to further bounce in Emerging markets and Materials



Short-term (3-5 days):  Bearish- The near-term trend has turned bearish after the break of 2886 in SPX cash last week.  Pullback looks to be underway that could take S&P down to 2823-35 and below that to 2775-80 before this is complete.  The selloff in the bond market directly coincided with Equities starting to rollover last week and we saw Technology break support relative to SPX which is important given its 26% weighting in SPX.  Breadth and momentum have been negative and downward sloping while not yet signaling any real support after just a few days of decline.  Yet, looking back, S&P ended up peaking on/near 9/21.  For this coming week, getting under 2869 in SPX cash would allow for a final pullback into late this week (2873-S&P Futures)   To have any sort of confidence that this move was just a few-day pullback, we'd need to get back up above 2921-SPX, yet it's imperative to see Technology and Financials start to stabilize and turn back higher relatively as both groups have been under pressure lately. 

Intermediate-term (3-5 months)-  Bullish-  No change-  Its thought for now that pullbacks should be buyable as no real intermediate-term weakness has occurred and momentum weakness is short-term only and has not affected the weekly charts.   If trend channels from late April are broken (2775-80 in SPX) ahd happen in NASDAQ, DJIA, while weekly momentum starts to rollover, it would be right to expect a larger correction.    (From last week:  The beginning of Q4 kicks off the most positive stretch for Equities seasonally within the four-year election cycle.  Barron's notes this past weekend that combining the fourth quarter of a mid-term election year with the first two quarters of the 3rd year of a presidential term averages 20.4% since 1950.  Mid-term Octobers also rank as top months for performance, with average gains in DJIA of 3.1% since 1950, with 12 of them being higher and five being lower since that time.   Impressive seasonal stats for sure, however, the mid-term 2nd and 3rd quarter performance certainly deviated from the traditionally sub-par performance which happens during these years, and SPX has now strung together six straight positive months.  Overall, given the monthly close at new all-time highs for US Equities, it remains difficult to be bearish on an intermediate-term view without any semblance of weakness heading into this seasonally positive time.  However, the recent breadth deterioration, Financials weakness, and momentum waning combined with bullish sentiment are real concerns to those that simply argue a bullish tune based on price alone without studying the underlying weakness.  Bottom line, it seems more likely than usual that October turns out to be far less positive than these seasonal stats suggest.  A selective stance is preferred with overweights in Energy and Healthcare, keeping alert for evidence of any downturn that might change the thinking that dips are automatically bought.  For now, price trends and seasonal factors outweigh the breadth concerns which have all been present for some time, with little to no effect.

10 Important charts which illustrate some of the key technical moves of this past week and what might be expected going forward


SPX-  Trendline break likely results in weakness to the lows of SPX larger six-month channel, but still looks near-term only.   The weakness last Thursday/Friday managed to finally violate the uptrend which had been tested no fewer than three times since started in late June.  Signs of negative momentum divergence ( price moving higher, but momentum not following suit ) had been ongoing for the last month, and we've seen evidence of Technology starting to rollover along with Financials (despite Thursday's bounce)  Overall, gauges of technical momentum like MACD are negatively sloped on daily charts and given the recent uptick in bullish sentiment, (with bullish readings as high as this past January) further near-term pullbacks look likely before this move is complete.  Support on this move initially looks to come in near 2832 for December S&P Futures and 2823 for SPX Cash.


SPX weekly shows extreme negative momentum divergence compared to this past January which will likely continue to be an issue for markets heading into next year.  At present, the move to multi-week lows last week likely should retreat to test the larger uptrend from earlier this year.  The area at 2820-35 is likely to prove pivotal.  Several key points to make on this weekly:  first, weekly momentum does remain positively sloped, so despite the divergence, weekly trends remain intact and positive at this time.  Second, no evidence of counter-trend exhaustion is complete on the SPX.  Thus, while the divergence is a larger issue, for now, drawdowns likely find support near this uptrend and should be buyable.  Breaks of this would be far more problematic for Q4 and at this time, are not expected right away.  


US 10Year Treasury notes breakout last week provided the catalyst last week for Equities to turn lower, despite the brief bounce in Financials.  As this monthly chart shows, yields have reached the highest levels since 2011, while successfully surpassing the long-term trendline channel that has been in place since 1994, over 24 years ago.  After two successful retests over the last couple decades, this trend looks to have been broken not just with US Treasuries and long-term bonds, but also with many European sovereign bond yield charts.   Near-term, it's likely that this rise stalls out and could backtrack in the next 1-2 weeks.  However, the long-term breakout at this point looks very much in place after last week's yield rise.  So near-term pullbacks in bond yields should represent chances to sell Treasuries. 


The Energy complex remains one of the better areas to favor technically in thismarket that has gradually begun to lose steam in recent weeks.   Charts above highlight the XLE vs SPX ratio chart, showing Energy breaking out of minor trendline resistance.   Thus, continues to get stronger, and just in the last week we've seen XLE start to make progress to join the strength seen in OIH and XOP.  There remains little evidence of a WTI or Brent Crude peak at this time and still likely that prices can push up into the early November sanctions vs Iran, despite some recent bearish inventory builds.  Overall, this minor breakout in relative terms should allow for further Energy outperformance as WTI and Brent Crude both turn back higher for a push up through the balance of October.  


Equal-weighted Technology has shown convincing evidence of rolling over in the last few weeks which supports the view that Technology should be avoided technically in the near-term until this correction has played out.  This is but one example of some of the sector rotation which has been ongoing in US stocks lately, where one group falls by the wayside, giving rise to strength in another.  In recent weeks, both Financials and Technology have been waning, with more evidence just last week that Technology has further to go in showing a larger correction.   Relative charts of the SPXEWIN index (Bloomberg) which is an equal-weighted Tech index, has broken down vs SPX to new monthly lows violating the trend going back since 2016.  This is a particularly damaging sector breakdown given that Tech represents over 25% in the SPX.  


Equal-weighted Consumer Discretionary breaking down vs Equal-weighted Consumer Staples-  The ratio chart of Discretionary to Staples has violated the trend going back since late July, something which argues for a more defensive tone in October as Staples have been gaining ground to the expense of Discretionary.  This Equal-weighted version of this ratio gives a much clearer way of seeing this sector rotation unfold in a way where the large-caps don't dominate the picture.  Overall, the next two weeks should bring about further lagging from Discretionary relative to Staples and from an ETF perspective, one should favor RHS over RCD, expecting more relative underperformance out of RCD. 


Growth vs Value has also broken trendlines going back since April over the last couple trading days.  This has been a nearly uninterrupted uptrend for Growth vs Value since the Election, but is starting to show increasing evidence of stalling out and turninglower.  The ratio chart undercut the early September lows as of last week which also violated the longer-term trend from April.   IVW vs IVE is this ratio, which now looks to be rolling over.  One should choose value, or IVE as a preferred source for outperformance in October, expecting this trend to turn down even further.  


NYSE new 52-week lows have expanded now to the highest levels since early February. This daily chart shows 140 new 52-week lows as of last Fridays close, greater than the amount shown for Bulls, which numbers 22 as of 10/5/18.  While the bond selloff does indeed account for a number of new lows, this acceleration in the chart and breakout typically signals a cautionary time, and given the breakout above five former peaks in Newlows, its likely that further upside in this New Low ratio could occur early this coming week.  


Turning to commodities, Sugar is the latest example of a recent downtrend in this area which now looks to have given way to turning back higher.  The last few days oflast week saw Sugar break out above early September highs which signifies a bullish breakout above this longer-term downtrend line which has been lower throughout the year.  Rallying to new multi-month highs is bullish near-term, and likely carries this up to 13.50 without too much trouble.  The commodity rally looked to have gotten underway right near 9/20 and started out with metals following Energy as well as grains making a big bounce, while the Softs have slowly but surely also begun to participate.  If the US Dollar starts to make a larger pullback in the weeks ahead and start to weaken into 2019, this will help the bounce in the group begin to extend much more.  For now, near-term strength in Sugarlooks likely  and one should be on the watch for a more broad-based move higher out of commodities. 


Emerging market currencies have begun to show increasing signs of trying to stabilize lately and the JP Morgan Emerging market currency index has triggered its first weekly counter-trend exhaustion buy signal since the decline began to accelerate sharply early this year.  This will take some time given the degree of downward momentum being seen in this index, but similar readings look close for Emerging market stocks as well.  This should allow for a snapback in the EM group at a time when most had begun to avoid the EM space, and recent BaML Monthly Portfolio manager sentiment showed a very negative bias towards Emerging markets which means from a contrarian standpoint, both the equities and currencies could begin to work much better in November and December.