Rarely do economic indicators impact the equity markets anymore, however Friday’s employment report appears to have added a last straw to a number of over-committed trading areas, including oil having its best 1 week move in years (USO +9.3%). UST yields bounced (TLT-1.8%) in response to the perceived higher likelihood that the Fed would raise rates. In similar fashion, Utilities fell sharply (XLU -4.1%) and broke 46.79 support, precious metals fell sharply (DBP -2.6%) and broke 38.75 support. With perspective, this reaction to an economic indicator lags all others underscores the measure of short-term risk appetite. The steady drumbeat of data pointing to global slowing has narrowed investors’ focus with each upward impulse in volatility (VXX up 4.22% Friday but down 6.97% on the week). We get a strong sense that Friday’s move was driven by top-down factors.
We see the trend in risk appetite, while volatile short-term, as trending lower in the long-term time scale, with the intermediate- and short-term time scales either emphasizing or de-emphasizing the larger trend. This can be seen in credit spreads, which were down the week through Thursday, but remain significantly higher in February vs. December and especially versus a year ago. Notable dispersion elsewhere, such as funds flowing from Consumer Staples and Healthcare into Consumer Discretionary but not the Financials and Information Tech are an area of concern short-term. Further confusing the picture is the outperformance of Midcaps, which tested new highs Thursday (Small caps came up just shy of that measure). In the very short-term, we should keep in mind that Friday’s decline followed a breakout above the December consolidation.
Absent any trend, and with momentum zig-zags narrowing zero, the structure of the market provides little guidance on forward direction. Last week we noted the case for risk management and potential for downside, especially where price broke support. There is still room for further consolidation short-term, but this is in context of a still-intact market advance. Remember that investors’ alternatives all remain inferior to equities until rates move up significantly. How much they commit, and over what time horizons are issues feeding back into current volatility.
Intermediate-term, there was a reduction in new lows and the high/low index looks favorable, as does seasonal liquidity and the Presidential Cycle. If the recent history is any guide, a recovery in defensive sectors likely leads the cyclicals. Should Tech and Financials then show some leadership, news highs could follow. We expect that Energy and Materials remain range-bound at the sector level, limiting opportunities to single issue moves.
Shifting our focal length back to the macro for a moment, it’s worth mentioning that the US Dollar (USD) rally is extended short-term. Measuring last week as a single candlestick, we see a great deal of indecision and in the daily charts, a topping formation supported by a negative divergence in momentum. Should the dollar consolidate against the trading partner currencies, the ensuing recovery in the credit-glut fueled global carry trade gets a reprieve (an attempt to recover Q4 losses). Since 2009, this condition has favored equities, absent superior or equal alternatives. We should be mindful that should Treasuries sell off further, that liquidity will need a home and this home is likely higher-yielding equities.
Monday’s opening range for the SPX 2,048.85 to 2,053.61. A break above this range needs to fill the gap to Friday’s close to rally higher, with more resistance at Thursday’s high. A breakdown below this range suggests a test of 2,050 and 2,040.
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Managing Director, Chief Market Strategist