This Rotation May Be a Concern

Rotation has been the theme in equities this year, but is something different this time? Rotation within equity sectors has not been a negative for the overall indices in the US. When tech falls, financials, energy, retail, transports, something else is being rotated into which keeps the overall market tone positive. But, in the last month we have seen rotational unwind in country specific indices. Emerging Markets have been a market leader this year and EEM has held its adjusted 50 day mvg avg multiple times throughout the year. The Emerging Markets Index future has traded remarkably well within this ascending trend channel all year and with multiple pullbacks of approximately 4% several times. We are currently seeing another one of these pullbacks. Both EEM and the EM future settled below the adjusted 50dma (we take the low of the last 50 days) for the first time this year. Since the settles were only marginal, we will need to see what happens on Monday and if we get a two day, clean settle below there will likely be more downside potential here.

EM relative to the SP500 as shown here with EEM vs SPY has used the 200dma in the pair as a very pivotal technical point. Back in February the 200 day acted as key resistance, and once above it became pivotal support in April and May. Well, just in the last week there has been a significant unwind in the trade. This was a bit of a crowded trade and now EEM/SPY is breaking that pivotal support. The recent unwind may have even given a rotational boost to SPY in the last few days, along with anticipation of the US tax cuts. But, if EM and European indices continue to falter they will be a headwind for the US broader market.

Another potential concern for us may be the Eurostoxx 50. There has been some unwind of European indices vs SP 500 during November as well. This chart is Eurostoxx 50 vs E-Mini SP hedged, and it has fallen sharply after touching its 200dma on Nov 1.

Eurostoxx 50 has fallen by 5% from that November 1st high and nearly tested its key 200dma support on Friday. In August the Eurostoxx and DAX futures fell approximately -8% which weighed on the E-Mini SP 500 (it fell nearly -3%). Both European indices broke their 200 day moving averages briefly before regaining upside momentum. A settle below the 200dma in Eurostoxx 50 may be enough to force longs to lighten up on positions which may weigh on the US.

One of the recent concerns for the US equity market has been high yield after HYG broke below its 200dma in early November. This was the first real break of the key moving average this year and it is currently holding below it after retesting the level this week. The prior breaks in HYG were precursors for the S&P which fell approximately -3% in March and August, but not this time.

Nasdaq is still up +30% on the year, but has seen a pullback of almost -3% led by semiconductors. SMH has been a market leader, but has an -8% fall from last week’s all-time high after hitting its April 2000 bubble top. High fliers MU, AMAT, NVDA led the recent decline with MU leading the retreat, falling -19.8% from its November 24th high before bouncing a bit Friday afternoon.

Recent rotation out of tech has seen flows into transports and financials. The transportation ETF, IYT, has risen over +10% since its mid-November low and relative to tech heavy QQQ it is back testing its 200dma which has been very pivotal resistance. So, look for profit taking here unless this key is broken.

XLF has risen +17% from its September 7th low when it held its 200dma. Relative to the tech ETF, XLK it too is testing the 200dma in the pair.

We have seen rotation into banks as well, with KBE up over +22% from its September 7th low. KBE relative to SPY held its short term .618* retracement/resistance last week.

Retail has been a laggard all year, but it too saw rotation as XRT jumped over +15% since November 8th when XRT vs SPY bounced off of its long term .618 retracement support.

Energy had been another laggard all year until its recent rise of +27% from its August low. XOP has been the leading ETF in the space. XOP vs SPY is currently testing the 200dma in that pair.

The passive investment strategy has been trending all year as displayed by the TLT plus SPY chart. Several times this year we have seen TLT and fixed income futures find support at the trend line support in this chart. Currently at the top of the channel which may find resistance again…

Like I said, rotation has not been a negative for overall market tone this year. But, if Europe and EM continue to fall the US indices will be dragged lower. After all, this has been a global growth story. What we would need to see is lack of rotation in the US sectors for a pullback of any consequence. With significant gains recently in several sectors, a pause may be in order for them. Tax reform coming to a head, and priced in. What could go wrong? It's usually something the market is not anticipating...

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