Below is an assessment of the performance of some of the most important sectors and asset classes relative to each other with an interpretation of what underlying market dynamics may be signaling about the future direction of risk-taking by investors. The below charts are all price ratios which show the underlying trend of the numerator relative to the denominator. A rising price ratio means the numerator is outperforming (up more/down less) the denominator. A falling price ratio means underperformance.
LEADERS: THE DANGEROUSLY NARROW TECH RALLY
Technology (XLK) – The Only Outperformer
The U.S. market has become historically tech-heavy to the point where it was the only sector to outperform the S&P 500 last week. Tech bulls will argue that this is simply healthy leadership from one of the economy’s strongest sectors. A lack of market breadth, such as what we’re experiencing now, is usually a bad thing as it indicates weakness almost everywhere else. When investors focus on just a half dozen stocks, it creates huge valuation disparities that can trigger potentially violent reversals.
Long Bonds (VLGSX) – Markets Turn More Dovish
Even though Powell dialed back the Fed’s rate cut forecast at last week’s meeting, the markets seem to think that cuts are even more likely than before. I think we need to wait and see whether or not May’s cooler inflation reading is a new trend or a one-off outlier. History would suggest that it’s more likely to be an outlier, but when investors are desperately looking for evidence that would support more rate cuts sooner, you start to see big drops in yields.
U.S Dollar ($USD) – BoJ Might Intervene On Behalf Of Yen Again
Even though the dollar is capturing a positive interest rate differential relative to the ECB and Bank of Canada, the upswing was happening well before those central bank cuts. The yen is still falling relative to the dollar and, while there’s the potential that the BoJ intervenes again and temporarily drives the dollar index lower, I believe there’s a hint of safety demand here due to growing macro-level weaknesses.
LAGGARDS: AFTER A YEAR, JUNK BONDS ARE FINALLY STARTING TO BREAK DOWN
Utilities (XLU) – Could Still Be The Big Winner
Utilities was the one sector that was standing up in the face of the mega-cap rally, but that looks like it has completely fallen apart. Like other sectors, utilities should benefit from lower rates, but the broad shift favoring tech and growth stocks seems to be winning out for now. I still believe that this sector will be the winner when all is said and done this year, but it could take some time for building credit risks in the U.S. economy to play out in the financial markets.
Industrials (XLI) – Looking Overdone
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