The minor consolidation Thursday might not be complete and still looks likely to give Bulls some opportunity to buy dips for those who didn’t participate in early week strength. However, in the bigger picture, rallies back up to test 3980-4050 look likely into October expiration, and pullbacks should be used to add to trading longs. Overall, trends remain down, but near-term momentum and breadth have turned up with price early in the week. This technical improvement is likely to lead further to the upside at a time when very few seem properly positioned. Thursday’s churning in SPX directly coincided with Treasury yields turning back higher. This might last another couple days, but rates are close to turning down, and expect Treasury yields to weaken into late October. This should coincide with an Equity bounce not dissimilar from what happened early in the week. While a move back above 4050 should be necessary to have great hope on SPX extending gains materially, a long bias still looks correct.
Energy continues to strengthen and should be favored
Energy’s best week in the last seven months directly coincided with WTI Crude oil rallying sharply this week. Further gains in Crude might prove difficult over the next 4-6 weeks, and it’s still anticipated that Crude might settle to the low $70’s or even high $60’s before stabilizing and turning back higher.
To its credit, Energy has been working quite well lately and breakouts are now happening again in the Equal-weighted Energy ETF by Invesco ($RYE) which should allow this sector to outperform in the weeks to come.
$XLE should be favored over $XOP and also $OIH until more evidence of Crude bottoming has occurred. (At this point, this WTI Crude bounce appears like a bounce only). Yet, downside in Crude and in Energy looks minimal in the bigger scheme of things.
Breakouts in RYE vs SPX in the lower part of this chart below are constructive towards thinking Energy outperformance can continue. Stocks like $HES and $MPC are part of my new “Upticks” list and are ones to consider within Energy for those looking.
Utilities needs to bottom immediately to avoid a larger breakdown of support
Charts of $XLU and the equal-weighted Utilities ETF, $RYU from Invesco, show Utilities having pulled back to very important make-or-break support. It’s necessary to hold this area, and I expect to see support at $64.33-$65 hold by end of week before a snapback in XLU into next week.
However, when eyeing relative charts of Utilities vs. SPX, there’s been some disturbing evidence of RYU breaking nearly one-year uptrends vs SPX on a relative basis. This is a technical negative that will be difficult to reverse barring a very violent upside rally in relative terms in the near future.
My technical thinking is that Utilities should bottom out and rally in the days/weeks to come. However, any failure to regain September highs (which should be difficult to recoup given the magnitude of our recent decline) would point to a greater likelihood of a bigger breakdown in this sector.
Weakness in Defensive groups does look likely to me technically between October and December as I expect a return to “risk-on” sectors coinciding with rates rolling over. Thus, any rally into mid-to-late October should be used to contemplate diversifying away from Utilities given this meaningful relative weakness.
Top Utilities which look appealing to consider after recent weakness center around $CEG, $NEE and $SRE. However, these should be “kept on a tight leash” given the amount of weakness in this sector.
High Yield strength is seen as a positive for risk assets
One interesting phenomenon lately has centered around the deterioration in the spread of Investment Grade Corporate ETF ($LQD) in ratio form to the High Yield Corporate ETF ($HYG) (One can also substitute $JNK, which gives similar results).
As seen below, this ratio has broken down to the lowest levels of the last couple years this week. This speaks to the degree of High yield corporates rebounding lately and is seen as a technical positive for the appetite of risk assets.
One can also view the Option Adjusted Spread which was noted recently by Tom Lee in his recent research as having diverged from June lows.
As seen below the highest spike on this graph happened into March 2020 before this began a steep slide. This has remained trending lower and likely pulls back into December 2020 before a sharp rebound.
While not shown below, the weekly chart shows intermediate-term support materializing on further weakness in this spread into year-end. Thus, in the bigger picture, this suggests that strength in High yield might take the form of a big bounce in Q4. Yet, this might provide opportunities for “the Bears” heading into early 2023.