Interest rates continue to play a primary role in influencing sector leadership in the US equity market and they remain top of mind for us. We had warned about an upside break-out above the 4.7% level, and for almost a week, getting cautious was the right move. However, rates have now retraced the break-out and are trading lower towards near-term support over the past 4 days, calling into question the upside move. We see the zone between 4.5% and 4.7% as a transition area for interest rates (Chart below). Above that level, we would expect a mix of Value and Defensive equity exposures to outperform, below that level, we would expect Growth stocks to lead and the bull market to ramp back up.
The S&P 500 has rallied with rates retracing their recent move and price is testing resistance (chart below). We have a tactical MACD buy signal here, but there have been several near-term price gaps within the latest rally that make us expect some continued consolidation.
S&P 500 internal strength had reached wash-out levels or weakness with the % of stocks above their 50-day moving average moving below the 20% threshold 3 times in December and January (chart below, middle panel). We’re starting to see a rebound there, but the buyer is falling short of bullish confirmation. Typically, when internals get to readings of extreme weakness, the buy signal is a response of overwhelming strength. When looking at Advancers/Decliners (chart below, bottom panel) we’d expect to see some >90% readings for advancing stocks, but that indicator has fallen short in the past week.
Looking at sector performance (chart below), Discretionary stocks have made gains in the past week along with Financials, Energy, Materials, Industrials and Utilities. Comm. Services and Technology shares have continued to lag along with Staples and Healthcare.
When we look at the sectors through our trend-following process, Financials are set up for continued outperformance from here, as the bullish trend there is relatively young. Financials continue to recover from the mini-banking crisis of Q1 2023 and they are just now on the cusp of starting an outperformance trend vs. the S&P 500 whereas Tech and Comm. Services outperformance trends are potentially long in the tooth.
From a macro perspective, we are impressed by the buyer’s response to “softer” CPI data last week in the face of stronger economic prints in weeks prior. While we agree that lower readings are more salubrious for the bull market trend, we are confused as to how 1/10 of a percent lower is interpreted as a materially bullish development. We would expect going forward that perceptions of inflation will continue to be shaped by very small oscillations in the economic data and we will be looking at our macro indicators with a bit more skepticism moving forward if this is the case.
One development that confirms inflation concerns in the near term is sharp bullish reversals in Crude and Commodities prices. The Bloomberg Commodities Index took out a recent near-term high at 102.98 and is now in a bullish reversal price structure (chart below). The RSI study for the index shows an overbought reading, but continued strength here supports the idea that rates aren’t done moving higher. We’d need to see Commodities prices retreat with rates to feel good about re-entering Growth sector longs.
Crude is confirming the bullish reversal in Commodities (chart below). We have a tactical long position on for the Energy sector and we will revisit at the end of the month.
We continue to focus on marginal inputs into the inflation trend because of the macroeconomic backdrop for the Consumer. Housing affordability continues to be punk, due to a mix of high rates and low inventory. Housing starts have ticked higher recently, but profitable homebuilding is expensive/luxury homebuilding these days. We aren’t seeing any obvious relief on the horizon for the consumer if it isn’t interest rate relief, and we worry that any negative “wealth effect” from a correction in stocks due to rising yields (stock value and bond value both going down at the same time) would put the consumer (and the bull trend for equities) in a tough spot.
Lower rates are beneficial in two ways. They provide direct relief for the consumer around financing costs, housing affordability and credit availability, but they also benefit Growth stocks, by lowering the present value of debt and raising the present value of potential out-year earnings. So, while we hope we aren’t getting tedious with our focus on rates, they remain the lever that sets things in motion for the present.
Patrick Torbert, Editor & Chief Strategist, ETFSector.com
Data sourced from FactSet Research Systems Inc.
