foxex: Mild Rebound

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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Tuesday, July 14, 2020

1. Buyers not scared away as stocks rebound

2. One surprising sign the U.S. economy is okay

3. Banking stocks haven't joined the rallies...yet

Market Moves

The S&P 500 (SPX) and the Dow Jones Industrial Average (DJI) outperformed the Nasdaq 100 index (NDX) today as stocks rebounded from yesterday's rotation-driven selling. Even as investors took profits from tech company stocks, they seemed determined to put their money right back to work in less volatile equities. The move wasn't exactly a flight from risk, however.

The chart below compares the movement of Invesco's Nasdaq 100 index ETF (QQQ) with iShares' Russell 2000 small cap index (IWM). The comparison notes how the small-cap ETF is rebounding to a greater degree than the Nasdaq 100. This is a very subtle but important indication. If investors were afraid of risk right now, IWM shares would be rising proportionally less than QQQ, not the other way around. The relative strength shown in IWM shares is good news for bullish investors.

One Surprising Sign the U.S. Economy is Okay
Homebuilding companies are part of a specialized industry group within the Real Estate sector. This industry group is an excellent indicator for the economy in general because the purchase of a new home implies the purchase of many other things at the same time: a mortgage contract, furnishings, landscaping materials, etc. If the stocks in this industry group are doing poorly while the rest of the stock market is charging higher (that's how it happened in 2006 and 2007) it will be a sign of brewing trouble. For now, that doesn't appear to be happening.

Despite the all-too-real effects of the pandemic, people are still building and buying homes. The chart below compares State Street's Homebuilder index ETF (XHB) with two stocks leading it higher: Home Depot (HD) and Lennar (LEN). Each of these two stocks made its highest close since the pandemic lows today.

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Banking Stocks Haven't Joined the Rallies...Yet

This week the majority of major banking companies report their quarterly earnings. This morning J.P. Morgan Chase (JPM) and Wells Fargo (WFC) reported before the bell. Tomorrow Goldman Sachs (GS) and Morgan Stanley (MS) will do so, with U.S. Bancorp (USB) following on Thursday. The chart below provides a snapshot of these three. Analysts are watching this sector closely for signs that financial sector companies may begin to catch up to tech stocks and be the next group to rally. If that doesn't happen, it is a bearish signal for the market in general.

The Bottom Line

Investors were more enthusiastic about moving money into manufacturing and service companies that appear to deliver less volatility. However, the sector rotation did not give an indication that investors were ready to stop risking money altogether. To the contrary, small-cap stocks seemed to rise better than the large-cap counterparts. Financial sector stocks haven't started up trending strongly yet, but many analysts expect that they may.