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Road Ahead 'Choppier,' But Tech Snapback Could Keep Rally Going Into August

By Mark L. NewtonStock MarketsAug 04, 2020 01:08AM ET
www.investing.com/analysis/the-road-ahead-could-prove-choppier-but-technology-snapback-likely-keeps-rally-200532871
Road Ahead 'Choppier,' But Tech Snapback Could Keep Rally Going Into August
By Mark L. Newton   |  Aug 04, 2020 01:08AM ET
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Gains in stock indices are likely to moderate over the next 6-8 weeks now that markets have entered a seasonally more challenging time. Despite indices ability to log further gains of 5% in the month of July, divergences are continuing to build between the V-shaped stock recovery and the broader economy, which is only gradually stabilizing after suffering the worst shock in over 90 years. 

Technically the concentration of the “Big Five” stocks as a 20%+ percentage or more within indices like the S&P 500 and NASDAQ 100 has certainly been noticed by the broader investing public, and historically have coincided with both of our bull market peaks since 2000. Yet it remains difficult to diversify out of US stocks given little to no real evidence of price weakness.

Weekly momentum remains bullish and upward sloping and has largely avoided getting overbought in most sectors. Meanwhile, sector participation actually improved quite a bit in the month of July with IndustrialsDiscretionary and Healthcare stocks gaining ground to help bail out Technology.

Yet the Treasury rally has begun to spook investors with the creeping realization that plummeting bond yields tend to cast little to no confidence on the possibility of any kind of strong 2H economic rebound.

So, what are the real concerns as to why August might prove “choppier” than July?

Cap-weighted index price trends certainly haven’t turned down, that’s for sure. July’s price action was far more bullish than we saw in June, closing near the highs of the range with the highest monthly close ever for SPX, with July’s 3271 close bringing prices just 4% from intra-month peaks and up 5% from June’s close at 3100.

However, equal-weighted indices haven’t fared nearly as well, and many stocks remain lower from early June. Moreover, intra-market divergences are continuing to build, and are something to play close attention to. The Dow Jones Industrial Average remains over 2,000 points below its all-time high monthly close, diverging substantially which would be even weaker if it weren’t for Apple's (NASDAQ:AAPL) strong gains.

The Dow Jones Transportation Average also lies more than 13% off its all-time highs while Small and Mid caps have struggled to keep pace with Large Cap Growth. Much of this divergence started nearly two months ago, and while this doesn’t portend an immediate mean reversion in the NASDAQ, it is something that’s a concern.

Furthermore, the negative momentum divergence based on indicators like RSI is also important to note, as indices have showed weaker momentum on the push up into July 22 then they had back on July 13’s peak, or even back on June 8th. (i.e. prices are higher in some indices, but momentum is lower).

As mentioned, the extent to which stocks and bonds are rallying together also is different than what’s been seen in the past year and this relationship also began to splinter back in early June. Finally, the push towards more defensive sector rotation is also something to highlight, as Utilities turned in the top performance for the month of July, outpacing all other 10 sectors, while Consumer Staples) outperformed Technology.

The positives, however, deal largely with the ongoing bullish structure and general lack of deterioration. Yes, the fact that trends continue to show upward sloping price behavior with higher highs, higher lows and higher, monthly closes will continue to be something to champion as a bullish factor until at least some evidence of price weakness occurs.

Weekly technical momentum indicators like MACD are bullish and RSI is not overbought, while breadth has generally been more positive in the month of July than it was in June. Furthermore, the US dollar showing its largest monthly decline in the last decade has had a positive effect on multi-nationals in making US goods cheaper to overseas demand and has served as a definite tailwind which can explain US equity gains in the absence of profits and/or a COVID-19 vaccine.   

However, perhaps the most important factor as to why one should remain in equities has to do with Sentiment which has arguably not budged from subdued levels in recent months. While investors are quick to point out the low put/call ratios and day trading bonanza as being a return to speculation, most conveniently ignore the recent uptick in COVID-19 cases along with the heightened tension in the US/China relationship and the rise in civil unrest, with rallies and riots gripping some of the major cities.

This does seem to be a factor in causing bullish sentiment to be tempered. Last week’s AAII data showed bullish sentiment among the lowest 40 readings ever in the survey’s over 1700 weekly samples. Only 20% of participants were bullish, while over 48% were bearish. This has directly followed a more than 40% gain in equity indices but goes to show that while institutional investors might be participating, the average investor remains more cautious, for some very understandable reasons.

However, a plethora of different cycles, Bradley and Gann related, show the potential for a turn in the month of August, starting as early as August 14th until August 21st, with September having a definite “down” bias based on Gann’s Mass pressure chart for 2020 which directly lines up with weaker seasonal tendencies during Election years.

The negative momentum divergence along with Treasury yields dropping and USD/JPY falling could certainly have some importance to the start of some breadth divergence for equities that finally causes some stall-out by mid-August.

Bottom line: I am expecting that August very well might bring about a change of trend, but looking out, I’m thinking increasingly that Q4 can be positive, with the added uncertainty of the US election being yet another reason for optimism, from a contrarian standpoint.

Whether or not the recent Tech resurgence means that this value trade can be put on the back burner again quickly is yet unclear.  In the short run, Technology does still look to lead, given equal-weighted Tech indices like Invesco’s S&P 500® Equal Weight Technology ETF (NYSE:RYT) pushing back to new five-month highs. 

Overall, the risk-on trade remains in force and the next few weeks look positive before a stall out.

Road Ahead 'Choppier,' But Tech Snapback Could Keep Rally Going Into August
 

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Road Ahead 'Choppier,' But Tech Snapback Could Keep Rally Going Into August

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