Market Update: August 03, 2021

Strong Rally Continues

Last month, I wrote that the current rally was outpacing the strongest rallies off prior bottoms. This trend has continued; moreover, the gap between rallies is growing.

Consider Figure 1: if we had invested $100 at market bottom in 1982, 2009, and 2020, then after 340 days, we would find that the $100 invested at the market low in 1982 or 2009 would be worth about $160. In contrast, the current rally has not yet entered its second-year consolidation; in fact, the S&P 500 index continues to forge new highs and has now gone 240 days (i.e., since 8/18/20) without drawing down by at least 10% from the high. That same $100 invested at market bottom in 2020 would be worth almost $200 in the same number of days since market low.

Figure 1. On the index level, the gap between the current rally and the rally off prior bottoms continues to grow

Source: Balentine

Historical Precedent Suggests Bumpiness Ahead

However, as we have been alluding the last few months, history dictates a pause is looming. This can be seen on a few fronts.

Equal Weight Index

First, the equal weight index has yet to break to a new high in almost three months. Figure 2 illustrates this point by utilizing the S&P 500 Equal-Weighted Index. Like the S&P 500 Index, this index shows the value of the market over time. Unlike the S&P 500 Index, the S&P 500 Equal Weighted Index gives equal weight to each company in the S&P 500. This provides the opportunity to see trends in companies outside of the five or six behemoths which take up most of the market share in the S&P 500 Index. In this case, the S&P 500 Equal Weighted Index shows that when we look beyond market heavy-hitters, the overall market is stagnating.

Figure 2. Under the surface, the index has already been consolidating.

Source: FactSet

Breadth

Breadth refers to whether stock prices are increasing or decreasing in the market in comparison to its 50-day moving average. Figure 3 shows that in April, 80-90% of stocks were in an uptrend. Now, you can see that the percentage of stocks over the 50-day moving average is beginning to level off, and in some cases, decrease. As of today, the percent of stocks above the 50-day moving average is hovering in the mid-50s (Figure 3).

Figure 3. Breadth remains weak, though is showing signs of stabilization.

Source: FactSet

Headlines

Last month we noted that bullishness was pervasive, which generally is a harbinger of more modest returns in the near terms. Well, nothing changes such bullishness like a change in the headlines, which often change more quickly than one would expect.

• July 18 – Financial Times – “US surgeon-general warns of more local mask mandates as Covid surges - Vaccination campaign has stalled and infections are rising for the first time since January”
• July 19 – Reuters – “U.S. issues 'Do Not Travel' advisory for UK over COVID-19”
• July 19 – Wall Street Journal – “Covid-19 Worries Ripple Through Markets - Behind the rout, investors say, is a growing list of concerns about the recovery”
• July 19 – Bloomberg – “Long-Term Treasury Yields Plunge as Investors Rethink Growth”
• July 19 – USA Today – “Olympic officials' nightmare scenario around COVID has become reality”

Not surprisingly, these headlines coincided with the July 19 market meltdown that shook out weak holders and may have formed an interim bottom. What remains to be seen is whether that level will mark the low of this consolidation, which would be quite a feat given that decline would represent merely a 3.7% drawdown from the theretofore index high, a far lower-than-average correction.

We believe the data presented above indicates some modest divergences, which align with our belief that the next few months will be relatively bumpy due to:

1. a hot market for ~17 months with little breather to date,
2. a glut of underlying bullishness,
3. market erosion the last three months under the surface being masked by strength in the largest market capitalization names, and
4. the weakest seasonal stretch of the calendar per historical precedence (i.e., July through mid-October).

A Pause Before the Next Leg of the Bull Market

This upcoming pause is not, however, to be confused with some sort of major top; rather, it should refresh the bull market and allow it to gather strength to forge the next leg higher.

Market 50-Day Moving Average

So far, the 50-day moving average continues to buoy the market. In Figure 4, the red line represents the 50-day moving average and the black line represents the S&P 500 Index. When the black line is above the red line, it signals that the market is trending up; conversely, when it is below the red line, it signals the market is moving down. We can see that the black line has hit the red line six times since the beginning of 2021 without dipping below, which means that the market is trending up overall. This also shows that momentum is intact and that every additional bounce strengthens that support; the bad news is that if the strong support breaks, then that usually indicates larger downside than if weak support breaks.

Figure 4. The 50-day moving average has served as strong support and did so again during Monday’s sharp pullback.

Source: FactSet and Balentine

Market 200-Day Moving Average

If July 19 is not the low of the consolidation, which would be in line with historical precedent, we would look to the rising 200-day moving average (Figure 5) to serve as support for the correction. While the 50-day moving average provides a short-term snapshot of the market, the 200-day moving average takes a longer view. If the S&P 500 drops below the 200-day moving average, this could be an indicator the market has crested.

Currently, the 200-day moving average hovers around 3950 and rising by 2-5 points daily. Were the correction to continue, the math suggests that the weak seasonal stretch between now and mid-October would lead to a decline on the order of 8%-12% to the 3900-4100 range, in line with the median annual drawdown since 1980 of 10% (Figure 6). This would not be cause for concern; rather it would be in line with our expectations for a healthy market pause.

Figure 5. The 200-day moving average could serve as ultimate support of this market consolidation.

Source: FactSet and Balentine

Figure 6. A drawdown to the 200-day moving average of 8%-12% would be in line with historical averages.

Source: FactSet and Balentine

Three important additional observations of note:

1. Break-even inflation rates have begun to diverge from Treasury yields; while Treasury yields remain relatively low, break-even rates are trading at roughly 6-week highs. The change is subtle, but with the reflation story left for dead, this is yet another sign that the market may be seeing the reflation story differently. Previously we have seen renewed life from Copper and other industrial metals, both the commodities themselves and the associated stocks.
2. The rally in the U.S. dollar index (i.e., DXY) seems to be stalling at the resistance level, with DXY struggling to push through the 94.50 to 95.50 zone. The trend is not yet bearish, rather more neutral, but if it is indeed beginning to roll over again, this correlates with the observations in point number 1.
3. It bears repeating that among the most defensive corners of the market, the Consumer Staples and Utilities sector, remain near multi-year relative price lows.

All these observations could correlate with a rotation back to the Value sectors of the market, most notably Energy, Financial, Industrials, and Materials, after a two-month pause in June and July.