by Andrew Adams CFA, CMT, Saut Strategy LLC
Charts of the Week
How do you force the stock market to break out from a month-long trading range? Why, just go on vacation, of course. Indeed, I spent most of the past week in Amsterdam on a relatively last-minute trip, and in the days leading up to it I had a feeling that the long-awaited breakout from the 2820-2940 S&P 500 trading range would arrive just as I was departing. And, sure enough, my first day away from the screens the index rocketed above resistance to reach its highest point since the August 1 drop. Youâre welcome everyone!
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Due to the six-hour time difference and the fact I was supposed to be enjoying myself, I really only checked in late in the day when U.S. markets were near the close. It was wonderful, but also a little ironic since I was so far removed from what was going on despite being in the city with the worldâs oldest stock exchange (the Amsterdam Stock Exchange was established in 1602 by the Dutch East India Company). Therefore, Iâve spent more time the past few sessions thinking about flower and food markets than the stock market.
As I get caught up, though, it seems to be fairly typical action so far in the S&P 500 itself after such a high-profile breakout. To get that breakout, the index put in more than a 3% rally in three sessions and gapped up significantly last Thursday to leave the trading range behind.
Itâs not too surprising then that the index hasnât made much further progress since pauses or even retests back to the breakout point are common after such a move.
Trading breakouts and breakdowns can be tricky because they donât always work out as cleanly as the technical analysis textbooks say they should. When deciding whether to believe in a breakout or not, I often find myself playing the role of Wallace Shawnâs character, Vizzini, in The Princess Bride â where, in a battle of wits, he goes back and forth in a logical progression to determine whether protagonist, Westley (Cary Elwes), has put a deadly poison in his own cup or Vizziniâs (of course in the film the poison ends up being in both cups and Vizzini dies while a poison-immune Wesley survives⌠spoiler alert).
I always feel like Mr. Market is trying to trick me when such an obvious breakout occurs. A breakout above some sort of notable resistance is practically a requirement to get a more significant move higher so they are often costly to ignore. Yet, on the other hand, false breakouts are regular occurrences, too, and often trap traders and investors who enter positions right as the smart money is using the liquidity created by the clear signal to exit.
Of course, Technical Analysis 101 tells us that weâre not supposed to assume a breakout or a false breakout before it happens, but late last month, I had a feeling that the breakdown in the Russell 2000 beneath support had a good chance to be such a false signal given its recent history and pointed it out in a report just in case a quick reversal did occur once again. So far that has played out nicely and now we turn our attention to this S&P 500 breakout to see how it progresses.
The most interesting thing to me about the action accompanying the breakout is that we seem to be getting clear rotations under the surface of the market. The best performing S&P 500 sector over the last week has been *gasp* Energy, followed closely behind by the Financials which, not surprisingly, may have bottomed while everyone was in the process of freaking out about the inverted yield curve. Meanwhile, Utilities, Real Estate, and Consumer Staples have all posted losses over the last five sessions after holding up nicely during August. It appears to be a case where winners are being sold while losers are being bought.
Bespoke Investment Group tweeted a very helpful graphic to show that during Mondayâs session the 50 best performing stocks YTD were down an average of 1.45% while the 50 worst performing stocks YTD were up 3.37%! A few days doesnât make a trend, of course, but it is something worth watching closely. If the market has turned a corner we may continue to see better participation by some of the beaten down areas like Small Caps, Energy, and Biotechnology.
I have seen a lot made on Twitter that Value is (finally) destroying Growth/Momentum over the past few days, which on the surface may sound like a negative given that Growth has led for almost the entirety of the secular bull market.
Yet, rotations like this one are healthy and if you drill down and take a look at what makes up some of the Value funds like the iShares Edge MSCI USA Value Factor ETF (VLUE), the top holdings are stocks like Intel, IBM, Micron, Bank of America, General Motors, Chevron, Pfizer, and Citigroup. I donât know about you, but I consider it a good thing when companies like these are doing well, especially when combined with outperformance by High Beta stocks over Low Volatility stocks, Small Cap Value over Large Cap Value, and Consumer Discretionary over Consumer Staples (see charts on pages 23, 24, 25). It looks like the weakness of the past year may have actually created some real value plays for once.
Market breadth has notably improved as well over the last week, thanks in large part to the rotations happening under the marketâs surface. The percentage of NYSE stocks above the 50-day moving average is now more than double what it was at the recent index lows (page 20) and the Advance-Decline lines for the various indices and exchanges continue to rise. Overall, then, this breakout in the S&P 500 and improvement in the broad market has to be believed until weâre given a good reason not to think itâs legitimate.
Therefore, the short term is pretty clear: the ideal scenario is that the S&P 500 stays above 2940 and breadth continues to improve in order to give the indices a chance to break out to new all-time highs. Itâs not necessarily the end of the world if the indices break back down into their former trading ranges, as the NASDAQ Composite did yesterday, but any retracement down within them should preferably be brief before the dip is bought once again. The wild cards, as usual, are any news bombs on trade and then next weekâs Fed meeting, when there is a 91.2% chance we get another 25-basis point cut according to CME Groupâs FedWatch tool. Despite the breakout, weâre still always just one tweet or Powell comment away from a drop, but thatâs the risk we have to take to own stocks right now.
Weâre also now approaching that major long-term resistance line once again Iâve highlighted several times (see page 8) in past reports. Itâs only about 2% above the current S&P 500 level and still may act as a cap for how high the index can go. Needless to say, however, that a breakout above that line would be yet another bullish development and would set the market up for an ever bigger move.
Thereâs quite a lot of upside space in many individual stocks and the Russell 2000 just to get back up to the all-time highs so the potential is there for broad market upside; the S&P 500 probably will have to break through that major resistance in order to get it, though. The long side should still be favored as long as this recent strength holds. Thereâs enough evidence to believe in the breakout from the August trading range and the green light has been given for now.
S&P 500 Sector Snapshot
S&P 500 Clear Breakout
August was a volatile month and saw a clear trading range develop in the S&P 500 between 2820 and 2940. The gap up last Thursday, however, took the index above that trading range and now the S&P sits above major support and all the key moving averages. Itâs a good sign as long as the breakout holds and we donât see a quick retreat back into the trading range. There isnât a tremendous amount of obvious resistance, either, up until the all-time high around 3025 so the bulls are being given every chance to build on this breakout.
S&P 500 Zones of Importance
It is obvious that the zones around 2950 and 2800 are massively important for the S&P 500. There have been numerous highs and lows made around these areas so they are worth watching very closely whenever threatened. Of course, now that the index is above them, they should act as strong support.
S&P 500 Major Ascending Resistance Looms Large
The fly in the ointment for this recent breakout is that it doesnât leave much space between the current S&P 500 level and the major ascending resistance line that has capped prices over the last couple of years. Of course, the index is capable of breaking above this line, but it will likely require some very real strength to do so. Right now it sits about 2% above yesterdayâs close. What we donât want to see is yet another sharp rejection off of it or, even worse, the S&P 500 breaking down before challenging it once again.
S&P 500 Big Picture Getting Cramped at the Top
The long-term chart of the S&P 500 demonstrates why a major breakout above that ascending resistance line is necessary â the chart is getting a little cramped up at the top after the index has made little progress since the start of 2018. Meanwhile, we continue to see lower and lower peaks in the RSI indicator (lower panel), signaling that momentum has slowed over the past couple of years. We really need to see another breakout accompanied by a pickup in momentum.
S&P 500 Not Extremely Extended
The S&P 500 may have gotten a little extended in the very near term after last weekâs move, but overall itâs not that stretched. Itâs not even one standard deviation above the 50-day moving average yet, where it has spent quite a bit of time during this bull market. Itâs notable, too, that the two standard deviation band beneath the 50-day moving average provided some nice support last month during the weakness.
Transports Trying to Break Downtrend
The underperformance of the Dow Jones Transports has received quite a bit of attention over the last year, but the index may be turning it around here now. The Transports have outperformed the Industrials during this recent bounce and are close to breaking out above the falling downtrend line that has capped the index since last September. Hopefully this reflects the marketâs improving economic expectations.
China Still Turning the Corner
The Shanghai Composite Index, as mentioned in recent weeks, continues to quietly look good after bouncing from major support. As we have seen in recent years, when China is in favor its stock market can move very quickly so this is worth monitoring closely.
Semis Leading
Another good sign is that the Semiconductor Index is not only participating in this recent rally, itâs leading the S&P 500. The semis are often a very good barometer of global growth expectations and willingness to take risk, so we want to see them leading like this.
Stocks Continue to Build Gains Over Bonds
I used this chart last week and so far the S&P 500 has held support against the 30-Year U.S. Treasury, implying that stocks are back to being preferred to long-term bonds. That is usually a positive for the stock market (obviously).
Small Caps Punishing Shorts
The brief false breakdown in the Russell 2000 beneath support has, not surprisingly, led to a quick 5% move to the upside. If the broad market has indeed turned a corner and the rotations of the past week continue, it may be a better environment for small cap stocks. Itâs still early to say that small caps should be preferred to large caps given the relative strength trend (lower panel), but itâs worth watching considering the strong moves small caps can make when in favor.
Oil Breaks Downtrend but Right Back to Resistance
WTI Crude Oil looks to have broken its downtrend since late April but the high $50s â low $60s area continues to be a likely resistance zone.
Energy stocks have acted better lately and more sustained strength in oil could help that outperformance continue.
NASDAQ A-D Line Improving
Thanks in large part to better action in small caps, the NASDAQâs Advance-Decline line has made clear improvement over the last week. We want to see this line continue to rise along with the broad market.
NYSE A-D Line Confirming Strength
The NYSE Advance-Decline Line, meanwhile, continues to hit new highs. As a confirming indicator, this helps have more confidence in the recent breakout of the S&P 500 and other indices.
NYSE % Above 200-DMA Creeping Back Up to 2019 Highs
Quietly, the percentage of NYSE stocks above the 200-day moving average is back above 60% and nearing the highs of earlier this year. This shows that breadth is definitely improving under the surface.
NYSE % Above 50-DMA Also Improving
Likewise, the percentage of NYSE stocks above the 50-day moving average, a more sensitive indicator, has gone from 26% to 63% in less than a month.
More Stocks Making New Highs Than Lows
Another good sign is that the 5-day total of stocks across the NYSE, NASDAQ, and AMEX making new highs compared to new lows is back to reflecting more new highs. Usually, itâs only when this indicator is negative (more new lows) that we need to be concerned about a bigger downside move in the market.
Value Outperforming Growth (No, Thatâs Not a Typo)
In a clear departure of the broad trend over the last 15 or so years, the Russell 3000 Value Index has greatly outperformed the Russell 3000 Growth Index over the last couple of weeks. Normally, this could be interpreted as a negative sign since usually we want to see growth leading, but based on other evidence and the kinds of stocks that actually make up the value index now, it seems to be more a sign that actual value has finally been found in the market and itâs just a rotation out of extended stocks and into more beaten down areas.
High Beta Still Outperforming Low Volatility
One main reason not to be worried by the Value/Growth relationship is that, unlike last Fall when Value outperformed, the more speculative âHigh Betaâ stocks have also outperformed more defensive and yield-sensitive âLow Volatilityâ stocks lately.
Small Cap Value Outperforming Large Cap Value
Moreover, when we go down the capitalization spectrum, small cap value stocks are outperforming large cap value stocks, another sign of a more ârisk-onâ environment.
Consumer Discretionary vs Consumer Staples
Finally, Consumer Discretionary stocks have outperformed Consumer Staples since the middle of August, yet another indication of an improving market.
Trade Ideas
The breakout in the S&P 500 and NASDAQ has helped create some more opportunities in individual stocks, though the rotation from strong areas to weak areas hasnât really helped those of us who like to focus on buying stocks that are holding up better than others. PAGS and SBUX from last week were two such stocks that had been doing very well but now appear to have fallen out of favor. PAGS had a nice quick ~6% run before falling off a cliff but SBUX never even got going. That is why stop losses should always be used. Meanwhile, the ROKU short finally worked, as it got caught up in the rotation out of extended stocks.
When I look for trades, I am looking for stocks I think can move in the direction I want them to go quickly while limiting my downside if I am wrong. I expect to be wrong a decent amount of the time given the tight stops, but the idea is that the winners should more than pay for the losers. There is an opportunity cost to holding a position, as the capital allocated to it prevents you from using that capital in another position, so if I enter a stock and it doesnât quickly do what I think it should I may cut it even though a stop or profit target isnât hit. Likewise, I usually move my stop up to my breakeven point once the trade starts to go in my favor in order to prevent a winning trade to turn into a losing trade. Understandably, my trading strategy might not fit your trading/investing strategy, but the trades highlighted in this report are the kinds that I typically look for.
Current Open Positions in Personal Accounts (this changes daily): Long TLT Sep20â19 140 Puts, Long BIDU, Long ERX, Long SLYV, Long ROKU Sep20â19 150 Puts, Long LABU
LONG: iShares NASDAQ Biotechnology ETF (IBB)
In keeping with the theme of rotation into beaten down areas, Biotechnology has been out of favor for a while but always has tremendous upside potential once some buying begins. The group greatly outperformed a flat market yesterday and is just above a major support area that goes back to 2016. If Biotech is going to reverse to the upside, now seems like the time for it to happen. Your Biotech product of choice can be used to play the theme, but Iâve used IBB here for illustrative purposes.
LONG: NVIDIA Corp. (NVDA)
NVDA was the hot stock for a very long time before it was cut in half during the drop late last year. Itâs spent the last 9 months basing but there are signs that itâs ready to make another attempt at significant upside. Thereâs been some high-volume up-days recently and itâs outperforming the broad market. Additionally, it has broken up through some resistance lines that confirm the strength behind it.
LONG: ServiceNow, Inc. (NOW)
NOW is another stock that was once a high-flyer but has recently taken a large hit. Yet, the area around $250 has a history of importance and NOW looks to have possibly falsely broken down yesterday under support before getting bought back up. I love trading these false breakdowns since they often lead to significant moves in the opposite direction and itâs easy to define your risk (read: get out on a break below yesterdayâs low). Moreover, while the stock made a new reaction low yesterday, it did so with a much higher RSI reading than in early August, signaling that downside momentum has slowed.
