February 21, 2020
Our note from January 17 and January 23 discussed the increased probability for a 2-4% pullback in the SPX based on decelerating price trend momentum and elevated bullish sentiment. A six-session long, ~3.2% pullback ended on January 31, but the ensuing ~5% rally in the SPX to new record highs was made on defensive sector leadership, which caused concern. In our view, new highs in the broad market made on defensive sector leadership are unsustainable. We wanted to see cyclical sector leadership, confirming new high from cyclical indices (SOX, DAX, NKY, RTY and SXAP) and 10-year bond yields back-up to at least ~1.70% before adding broad equity exposure. We also note narrowing market breadth (advance/decline line) over the past six sessions along with the familiar price trend deceleration that returned Wednesday. Collectively, it’s enough to expect another pullback or pause to support levels in the 3290~3310 range. It’s possible there’s a more significant downtick in store, but patterns suggest price exhaustion in defensive/momentum sectors only, while the cyclical/value groups bullishly consolidate. Note defensive sectors and momentum styles are extremely crowded at the moment, while cyclical/value offer a more compelling risk-reward. The set-up looks very similar to the August/September rotation into value but with more fuel from monetary and fiscal stimulus…a coiled spring if there’s reason for 10-year yields to lift above ~1.70%.