Yesterday’s sharp selloff was a problem.
No, that doesn’t mean we’re flipping the script and betting on the start of a big, bad bear market. But this damage probably takes some time to repair.
We’ve pointed to this divergence a couple of times over the past month. The S&P 500 Index has risen steadily all year, even crossing above 5000 and setting a new all-time high last week. The list of stocks setting new 52-week highs, however, stopped going up in December.
The post-CPI decline gave us some price confirmation for that divergence. Check out Consumer Discretionary, which is the subject of today’s sector deep dive. Last week, Discretionary stocks were hitting new 52-week highs. There’s nothing bearish about breakouts… but there’s nothing bullish about failing to hold that breakout. Especially when we see such a sharp bearish momentum divergence. At the mid-December peak, the 14-day RSI reached its highest level in 2 years, something we saw as confirmation that bulls were in control. On the most recent high, RSI couldn’t even reach overbought territory.
We’ve got the exact same signature for the equally weighted Consumer Discretionary sector, which strips out the oversized influence of the mega caps: a failed breakout with a huge bearish momentum divergence.
These types of divergences can be resolved in one of two ways: through corrective price action or through time. A correction through time is the more bullish of the two, and that’s what we think is the most likely outcome here. Some sideways action after a 20% rally in a couple months would be welcome.
There’s always the chance that this could turn into something more, though. What we’re watching for is an expansion in the number of new lows. Despite yesterday’s drop, the number of stocks setting new 6-month lows was still lower than we saw in January and even last week. There’s no reason to be aggressively negative on this market as long as that’s the case.
If we do see an expansion in the number of new lows, we’ll most likely need to see weakness spread to someplace other than Utilities, Staples, and Real Estate. In risk-on areas of the market, long-term trends are still quite healthy.
Digging Deeper
There’s a sharp dichotomy within the Consumer Discretionary sector.
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