Defensive sectors continue to outperform. Just like the dot-com crash for stocks?

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The S&P remains around its 2800 resistance area. Meanwhile, a look at some individual sectors illustrates something interesting about the stock market’s rally.

Go here to understand our fundamentals-driven long term outlook.

Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day.

*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are blindly “guessing” the future.

Defensive sector – utilities

XLU is the utilities sector ETF, which makes it a defensive sector. XLU has exhibited a clear inverse relationship with the S&P over the past few months

  1. When the S&P was doing well, XLU would be weak
  2. When the S&P was doing poorly, XLU would be strong.

Here’s a recent chart. Notice how XLU has done well from mid-February to present, while the S&P has been flat.

This consistently bothers me because the big divergence between utilities and the broad S&P is how the 2000-2002 bear market started. Utilities massively outperformed the S&P in late-2000 and early-2001.

But is this a cognitive bias? I.e. has this “divergence” occurred in bullish times as well as bearish times?

Here’s every single case in which XLU was up more than 10% over the past 5 months, while the S&P fell more than -6%

As you can see, all the cases cluster around 2 dates:

  1. October 2000
  2. February 2016

Both of these cases occurred around earnings recessions for the S&P 500.

  1. The S&P fell into an earnings recession by 2001
  2. The S&P was in an earnings recession by early-2016

Right now, analysts believe that the S&P 500’s earnings growth could also turn negative for Q1 2019.

Not a clear long term bearish sign, but something to watch out for.

XLU – short term deviation

The prior divergence was on a medium term time frame (5 months). XLU is also much stronger than the S&P on a short term time frame right now.

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XLU’s 14 day RSI is much higher than the S&P’s 14 day RSI, indicating more short term strength in utilities.

Here’s what happens next to the S&P when XLU’s 14 day RSI is above 77 while the S&P’s RSI is below 60.

This is more bullish than bearish for stocks 2-9 months later, with the big exception of the 2000-case.

Heavy Truck Sales

Heavy Truck Sales have made a new high for this economic expansion. In the weekly market outlook, I said that this is a bullish macro factor for stocks because Heavy Truck Sales tend to trend downwards before bear markets and recessions begin.

Nevertheless, such high Heavy Truck Sales is indeed a late-cycle sign for the bull market and economic expansion.

Here’s what happens next to the S&P when Heavy Truck Sales exceeds 540k

Notice how these are all late-cycle dates.

  1. March 1973: bull market already over
  2. September 1999: bull market has 6 months left
  3. February 2006: bull market has 1.5 years left

*I am aware that 540k Heavy Truck Sales 50 years ago is not the same as 540k Heavy Truck Sales today. However, it is quite remarkable how Heavy Truck Sales have consistently stayed within a wide range despite a 65% increase in the U.S. population over that same time frame. This is similar to Housing Starts. Housing Starts remains within a wide range despite a 70%+ increase in the U.S. population.

Inflation-adjusted new orders

Inflation-adjusted New Orders has made a new high for this economic expansion.

Let’s look at the pessimistic side of things. Let’s assume that inflation-adjusted New Orders has made a high for this economic expansion.

If this is the high, then it is still not a worry for the economic expansion. Inflation-adjusted New Orders tends to trend downwards before bear markets and recessions begin.

Pattern

The S&P 500 has fallen 8 out of the previous 9 days, and then spiked today.

Is this a bullish pattern for the stock market?

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Not really, although there is a slight bullish bias 3 months later.

Personally, I don’t use chart patterns. You can come up with an infinite array of complicated chart patterns and give them fancy names such as the right-hook-and-jab-crab-pattern (I made that one up – patent pending). But when you backtest these patterns, you’ll notice that most of them are not much different from random. Moreover, saying phrases such as “this ‘looks’ bullish/bearish” is problematic. People tend to see what they want to see. It is impossible to be 100% objective when staring at a chart.

The finance industry is full of things that sound smart but actually aren’t much different from flipping a coin in the long run.

Sustained strong breadth is coming to an end

All good things come to an end.

The S&P 500 had a very long streak with most of its stocks above their 50 day moving averages. One way to measure this sustained strength is to use a 14 day RSI of the S&P 500’s % of stocks that are above their 50 dma.

Here’s what happens next to the S&P when these sustained streaks of strong breadth end.

Could be a short term bearish sign, but is mostly bullish for stocks 9-12 months later.

Click here for yesterday’s market analysis

Conclusion

Here is our discretionary market outlook:

  1. The U.S. stock market’s long term risk:reward is no longer bullish. In a most optimistic scenario, the bull market probably has 1 year left. Long term risk:reward is more important than trying to predict exact tops and bottoms.
  2. The medium term direction (e.g. next 6-9 months) is more bullish than bearish.
  3. The stock market’s short term has a bearish lean due to the large probability of a pullback/retest. Focus on the medium-long term (and especially the long term) because the short term is extremely hard to predict.

Goldman Sachs’ Bull/Bear Indicator demonstrates that while the bull market’s top isn’t necessarily in, risk:reward does favor long term bears.

 

 

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