Market hitting resistance with breadth improving

We’re back from vacation to find the market mostly trading how we expected it to, since pivoting bullishly a couple of months ago. Our rally target has almost been achieved, with participation improving in the past week. There is also a sector and factor rotation in the works, that favours cyclical and economically sensitive stocks, while taking some air out of the A.I Tech factor that has dominated performance as of late.

There are a couple of notable events that could cause general profit taking this week, namely the Inflation numbers due to be released tomorrow (4.1% expected at the headline) and Wednesday’s Fed Interest Rate decision (75.9% odds of a pause). Should any of these surprise to the upside, then we could see the market consolidate in the current range, as traders find their excuse to take profits. For the moment, upside appears limited, even in the case of favourable developments in inflation and a pause in interest rates, which appear to be priced in currently.

SPY Analysis

SPY, the market benchmark ETF, has mostly priced in all of the upside we have envisioned. Resistance now sits immediately to the upside, at $431. With a 1.47 standard deviation extension (Z-Score) above its trendline, SPY appears to have found a ceiling for the time being. Theoretically, the next level of resistance is $449, but that appears a likely target for the end of the year, rather than something that can materialise faster.

It is the “rest of the market” that concerns us. Last week, Mid-caps and Small caps (orange, on chart below) have surged, in a sign that investors are finding alternatives to the tech giants that have dominated price performance during the last 6 months.

Volume on the rally has been decent, with recent inflows supporting the price action. Moreover, the entire recent trend of transaction volume has acted as a tailwind to the equity market, despite “liquidity drain” headlines and worries. To state this simply: there is sufficient capital at work, liquidity is not an issue for the time being.

When we strip out technology companies (including semiconductor stocks, Amazon and Tesla) from the S&P 500, we find surprisingly little price performance. This group of 395 companies has produced just 1.4% combined 6-month returns. If you haven’t been invested in the Tech sector, it’s likely your performance was flat (at best) this year.

Takeaway

The current set-up offers opportunity, as well as a degree of risk. The opportunity resides in “the rest of the market” being able to catch up to the main indexes, in terms of performance. Bulls would be well served to diversify across sectors and factors away from Tech and Mega-Caps. Literally everything else should rally.

We haven’t really reached exuberant levels of sentiment yet, despite the recent “Greed” rating on our indicator. Bears have not totally capitulated, so there is still some fuel left in terms of short covering. At the index level, we expect this to materialize as more of a consolidation / rotation pattern, than another outright surge.

We are content with our latest positioning, and looking to diversify away from SPY on the next leg down, and into individual stocks.