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Timing Models – Defensive Sectors Surge, SPY and QQQ Remain Extended, Bonds Bounce, New High for Fed Balance Sheet (Premium)

The bulk of the evidence remains bullish for stocks, but some yellow flags are starting to appear. Yellow flags argue for some caution and are not outright bearish. For example, defensive sectors are leading, but the offensive sectors are still holding up, even though they are lagging. Small-caps are also lagging, but the Russell 2000 ETF has yet to break down. Meanwhile, SPY and QQQ hit new highs just a few days ago. SPY and QQQ are also quite extended after big runs from early March to mid April. Again, it takes strong buying pressure to become overextended so this is not exactly bearish. It just increases the odds for a corrective period that may provide better setups in the coming weeks.

Report Summary

  • Defensive sectors leading, but offensive sectors still holding up.
  • Large-caps and commodities lead as bonds and small-caps lag.
  • SPY: long-term uptrend and short-term uptrend (extended).
  • QQQ: long-term uptrend and short-term uptrend (extended).
  • IWM: long-term uptrend and short-term trading range (lagging).
  • Composite Breadth Model: bullish since May 29th (bull market).
  • TLT extends oversold bounce as rising wedge forms.
  • The Fed Balance sheet expanded and hit another new high.
  • Yield spreads are low and show no signs of stress in the credit markets.  

Defensive Sectors become the New Leaders

The stock market turned somewhat defensive the last eight weeks with Utilities, REITs, Consumer Staples and Healthcare leading. The chart below shows the ten equal-weight sectors and the S&P 500 EW ETF (RSP). I am using the equal-weight sectors because they capture performance for the “average” stock in the sector. The equal-weight Industrials sector is also in the leadership group.

The equal-weight Finance, Technology and Communication Services sectors are underperforming, but they are still positive and their 8-week gains are impressive when viewed alone. The combination of relative strength in defensive sectors and relative weakness in offensive sectors is a yellow flag, but not outright bearish. The trouble starts when/if some of the big offensive sectors turn negative and experience real selling pressure.

Large-caps and Commodities Lead

The next chart shows performance for 14 intermarket ETFs since March 1st. SPY and QQQ are performing fine and in the upper half of this group. The Russell 2000 ETF (IWM) is the weakest of the group with a 1.99% decline. This shows both relative and absolute weakness. Commodities remain strong as well with the DB Agriculture ETF (DBA), DB Energy ETF (DBE), DB Base Metals ETF (DBB) and Gold SPDR (GLD) outperforming since March.

The equal-weight Finance, Technology and Communication Services sectors are underperforming, but they are still positive and their 8-week gains are impressive when viewed alone. The combination of relative strength in defensive sectors and relative weakness in offensive sectors is a yellow flag, but not outright bearish. The trouble starts when/if some of the big offensive sectors turn negative and experience real selling pressure.

SPY and QQQ Lead as IWM Lags

IWM is showing relative chart weakness as it corrects with a sideways range. First, note how IWM forged a higher high from September to October when SPY and QQQ forged lower highs. This showed relative and absolute strength in IWM (small-caps), and they went on to outperform from November to February. We now have the opposite because SPY and QQQ forged higher highs from February to April and from March to April. IWM did not exceed its February high here in April.

The Noose Tightens for IWM

Short-term, SPY and QQQ became quite extended with 11 and 14 percent gains from early March to mid April. Both are strong and in uptrends, but ripe for a rest after these big gains. IWM is also in an uptrend because it did hit a new high in mid March, even though it did not get back above its February highs this month. The noose is tightening because IWM closed between 217 and 226 the last 17 days, which is around a 4% range. We do not need Bollinger Bands to know that this is a volatility contraction and we should expect a volatility expansion. Watch 217 for a breakdown and 226 for an upside breakout.

Composite Breadth Model: Bull Market

The Composite Breadth Model defines the market regime and remains in bull market mode with all five inputs bullish.

Long-term breadth measures remain strong. Over 90% of S&P 500 stocks are above their 100, 150 and 200 day SMAs. Over 90% of S&P MidCap 400 and S&P SmallCap 600 stocks are above their 150 and 200 day SMAs. Performance differences start to emerge when looking at the percentage of stocks above the 100 and 50 day SMAs. Fewer than 90% of S&P MidCap 400 and S&P SmallCap 600 stocks are above their 100-day SMAs. 83% of S&P 500 stocks above their 50-day SMAs and just 53% of S&P SmallCap 600 stocks are above their 50-day SMAs. This is huge difference showed relative weakness in small-caps. You can read more about this in Wednesday’s article. [1]

The model and indicator charts can be found on the Market Regime page [1]. These include the Thrust Models for the S&P 500 and S&P 1500, and the Trend Models for these indexes. Declines and consolidations for the major index ETFs are considered corrections within the bigger uptrend as long as the Composite Breadth Model is net bullish. Note that this model is designed to absorb corrections and not turn bearish until the weight of the evidence is bearish.

You can learn more about the methodology and
historical performance for these breadth models in this article. [2]

TLT Extends Oversold Bounce

The 20+ Yr Treasury Bond ETF (TLT) is up around 5% since mid March with an oversold bounce. Note that it was oversold from early January to mid March, and just kept falling during this period. The retracement lines show that this bounce has not even retraced a quarter of the prior decline. The candlestick chart shows a rising wedge forming and the immediate trend is up as long as the wedge rises. A break below 138 would reverse this rise and call for at least a test of the mid March low.

Yield Spreads and Fed Balance Sheet

Investment grade yield spreads edged up a little this past week, but remain at very low levels and there are no signs of stress at the investment grade end of the bond market. The AAA yield spread is near its lowest level in over 10 years and the BBB spread is at its lowest level since January 2018.

The BBB yield spread is the difference between the yield on BBB corporate bonds and US Treasury bonds. BBB bonds are the lowest rated investment grade bonds. A low and/or narrowing spread (falling) shows increasing confidence in the credit markets, while a high and/or widening spread (rising) shows increasing stress.

Junk and CCC yield spreads narrowed from late September to early April and then edged up over the last two weeks. Even so, they remain at very low levels and there are no signs of stress at the junk end of the credit markets.  

The CCC spread is the yield difference between CCC corporate bonds and US Treasuries. CCC bonds are the lowest rated junk bonds (riskiest). A low and/or narrowing spread (falling) shows increasing confidence in low quality bonds, while a high and/or widening spread (rising) shows increasing stress.

The Fed balance sheet expanded by $28 billion this past week and hit an new all time high. Overall, the balance sheet slowly expanded from mid July to December and the expansion accelerated a little over the last few months.

Thanks for tuning in and have a great day!