By: Chris Rowe — July 13, 2021
Technical Tuesday - Declines to Come and Strength to Follow
And right now I’m seeing something we rarely see. Specifically, the stock market is sending out two very conflicting messages.
(If you're not up for the read, you can always watch the video below.)
I’m not telling you this because I think you’ll find it curious or interesting.
You need to be able to see what’s happening right now so you can steer your portfolio accordingly.
Now, as you’ve probably heard me say before, my investing framework stands on two pillars:
- Market Breadth (also called “market internals”)
- Relative Strength
(In fact, they represent the very first investing program I ever created, called the “Internal Strength System.”)
Analyzing the breadth of the market and its sectors (or any group of stocks) tells us if institutions are buying or selling the stock market and if they’re buying or selling specific or sectors within it.
We look at relative strength to understand which securities or groups of securities are seeing the most price strength.
This analytical concept can be applied to asset classes (to find if U.S. stocks are stronger than non-U.S. stocks, or if non-U.S. stocks are stronger than bonds, or if bonds are stronger than commodities, etc).
It can also be applied with a more narrow focus on sectors within an asset class (like whether Energy stocks are stronger than Technology stocks, or Healthcare stocks etc).
So, what’s the problem right now?
Breadth indicators are telling us that supply is very much in control of the stock market right now.
That's typically a warning sign that it’s time to play defense.
Look at this image of the US Sector Bell Curve (one of the custom tools that comes bundled with Sector Prophets Pro, our premium data and sector research platform).
(Click any image to enlarge.)
You can see that supply--colored red--is in control of 35 sectors or 78%. Demand is in control of only 10, or just 22%.
That’s a pretty serious red flag.
But when we use relative strength to find out where the price gains are the strongest, we see something very different—a very bullish story.
Here’s what I mean.
Right now of the six major asset classes, U.S. Equities is by far the strongest. That tells us that the deep-pocket investors of the world do not think the stock market is in any real trouble.
In fact, right now Small-Cap Growth stocks (typically viewed as riskier) are the strongest equities while Large-Cap Value stocks (typically viewed as safer) are the weakest. That’s just one sign of many that there’s a big appetite for risk (which is the environment bull markets thrive in).
And within the U.S. Equities asset class the riskiest broad sectors are the strongest while the safest broad sectors are the weakest.
Let’s look at those strong broad sectors. They are…
- Consumer Cyclical - this is the sector that outperforms when people have extra money to spend on luxury items.
- Energy - this sector gains strength when the economy is gaining strength. (After all, it takes energy to power businesses and factories and the like.)
- Basic Materials - same as Energy.
- Industrial - again, this broad sector is strong when the economy is strong.
Investors are piling into those sectors.
Ok, let’s look at the weak broad sectors. They are...
- Consumer Non-Cyclical - things like food, toothpaste, and other products people need and use every day
- Utilities - a classic “flight to quality” sector
- Healthcare - another “flight to quality” sector
This all suggests that investors are very much in a bullish (even very bullish) “risk on” mood.
We see this same posture with the other asset classes.
When we look at Commodities (which is ranked #2 after U.S. Equities) we see that Energy-related commodities are the strongest… while the traditionally safe Precious Metals are the weakest. This shows us that there’s no big interest in safety.
Under the Fixed Income asset class we find that the riskiest segments—U.S. High-Yield Bonds, a.k.a. “Junk bonds”—are the strongest. The safer Long Duration Treasuries and Short Duration Treasuries are the weakest. Again, no interest in safety.
This tells us that risk is on! Investors are buying the riskiest investments more than anything else. Seeing that much confidence would typically make me want to keep buying.
If you’ve been following us for a while, you may remember in 2018 we called the coming decline when the opposite was happening.
When the stock market was moving higher, we looked at the strength of the 11 major sectors and saw that the defensive (“safe”) sectors were actually relatively strong. This shows lots of interest in safety and low interest in taking risk—a classic precursor to a bearish reversal.
Utilities, Healthcare and Consumer Staples are all things people will pay for, come hell or high water.
What I’m telling you is—strangely—the supply side is in control of the stock market right now, generally speaking. You wouldn’t know it by looking at the most popular market averages, that give a strong weighting to the largest stocks in the index.
But the fact is most stocks aren’t doing well at all and there’s a very inaccurate message being conveyed by popular averages like the S&P 500, Dow Jones, and Nasdaq-100 (QQQs).
When it comes to market breadth, the picture tells us institutions are unloading. And so you should be prepared for a market selloff here.
But perhaps the good news is the relative strength picture. It’s telling us that even though supply is currently putting downward pressure on stocks, large institutional investors are favoring the higher risk areas of the stock market and of the global financial markets with respect to all asset classes.
And the latter is the bigger picture, the more reliable picture, the long-term picture.
Be ready for a short-term sell-off. But if that happens, you’ll likely want to buy the dip!
Check back with True Market Insiders when that happens.
Heck, check back with us every day!
Founder and CEO, True Market Insiders