Break-out Holds, as deal is reached

With markets closed for Memorial Day weekend, our analysis will be brief.

Technically, the equity market breakout has held up well over the past week, with democrats and republicans clinching a debt ceiling deal over the weekend. Markets have already priced in most of this news, with futures trading up slightly Monday morning.

Now, the US government will be in the position to issue more debt in order to refill the treasury and keep operating. This debt issuance will put upward pressure on yields and depress bond prices a bit further. Paradoxically, rising yields will act as a limit to the equity market rally, at least in the near term.

The near term risk-range for SPY remains 417 to the downside and 431 to the upside (our rally target).

SPY Analysis

Despite the breakout and seemingly “euphoric” index-level performance, the broad market is not optimistic at all. There are more stocks oversold than there are overbought at this point, which is counterintuitive to the recent headlines.

Comparing SPY to a combination of Mid and Small caps (MDY and SLY) is highly evocative in this regard. The recent index level performance has been almost entirely driven by the largest market cap companies, with A.I. exposure. The so-called “generals” - AAPL, MSFT, GOOG, NVDA, TSLA, AMZN have generated all of the upside for the S&P 500 this year.

The lack of follow through from the rest of the market is worrying, to say the least.

When stripping out the “generals” from the S&P500 and plotting a chart vs SPY over the last 2 years, we get a similar equity curve. This tells us that market breadth fears may be misplaced for the moment, as the recent performance has simply meant a lot of “catching up” from the tech oriented companies.

Yet we have to ask ourselves up to what point will the rally in tech last, given the extreme deviations in the sector currently.

Takeaway

We remain in the “cautiously bullish” camp for now, despite the weak breadth. A rotation trade from Tech to “everything else” seems inevitable at this point, if the rally is set to continue. In fact, this is the only way we see equities going higher in any sustainable way - Tech needs to consolidate without tanking the rest of the market.

Treasuries are starting to look attractive again, especially if a further slump due to extra debt issuance puts pressure on prices. As it is, yields are attractive as a risk-free option (4% +), when compared to the upside of SPY for now (3.57%).