Looking for market alignment

●The stock market followed through on Tuesday’s rally with more gains yesterday

●Tech and small caps have led the market in recent days

●Major indexes have established swing lows


In the markets, most things are relative. Context matters.

Exceptionally bullish years like 2017—which occurred after the US market had already established one of the great bull markets of all time—tend to make people forget that it’s not (for lack of a better word) normal for markets to go straight up all the time. And that puts everyone even more on edge when corrections unfold.

If 2018 had ended yesterday, the S&P 500 (SPX) would have posted a roughly 2% gain—disappointing, for sure, but still closer to the 50-year norm—the index’s 8.2% average return from 1967-2016—than 2017’s 19.4% "ka-ching" episode.

The lesson: Corrections are not fun, and there’s no telling what tomorrow will bring, but right now it’s difficult to objectively argue we’re experiencing stock-market End Times.

Yesterday, when the US market built on Tuesday’s rally and distanced itself a bit more from Monday’s nearly six-month low in the S&P 500 (SPX), a couple of unusual things happened, relative to the past few weeks of trading:

●The Nasdaq 100 (NDX) led the rally.

●Utilities, real estate, and consumer staples—traditionally defensive sectors—were the only SPX sectors to lose ground yesterday.

In other words, tech—the standard bearer of the bull, and the sector that took the most punishment in the recent correction—showed renewed upside momentum, while investors appeared to bail out of defensive sectors. The following chart shows the SPX, NDX, and the Russell 2000 (RUT) since September 20 (notice RUT has been edging higher since October 24):

S&P 500 (SPX), Nasdaq 100 (NDX), Russell 2000 (RUT), 9/20/18–10/31/18. Tech, small caps took biggest hits.

Source: OptionsHouse

You can’t declare the end of a down move based on one day (or two or three). What you can do is monitor market developments and see if different catalysts are aligning in a such a way that indicates the market has the potential to move in a certain direction. In this case, the “risk-on” characteristics of yesterday’s market action coincided with:

●The bullish SPX-VIX divergence described yesterday.

●The beginning of the market’s historically most bullish period of the year.

●The SPX and NDX both pulling back to the support implied by their early-May lows (chart below).

S&P 500 (SPX), 11/3/17–10/31/18. S&P 500 (SPX) price chart. Pullback to prior low.

Source: OptionsHouse

Of course, all this could just as easily translate into the two-day bounce we’ve already seen as it could a two-week or two-month rally. But it’s also true that some give-back of the Tuesday-Wednesday rally wouldn’t derail the bullish case—many traders would anticipate such a pullback, if not a test of Monday’s lows.

But sustained rotation and the ability to hold above that low could lead some traders to look for additional upside, in which case beaten-down tech (and small-cap) names could attract extra attention.

Market Mover Update: Housing stocks, which went parabolic on Tuesday, mostly held their ground or dropped modestly yesterday, although Toll Brothers (TOL) rallied another 2%-plus intraday.

Today’s numbers (all times ET): Productivity and Costs (8:30 a.m.), PMI Manufacturing Index (9:45 a.m.), ISM Manufacturing Index (10 a.m.), Construction Spending (10 a.m.). Today’s highlighted earnings: Apple (AAPL), Arista Networks (ANET), EPAM Systems (EPAM), Spotify (SPOT), CBS (CBS), Kraft Heinz (KHC), Starbucks (SBUX), U.S. Steel (X).


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