The Wizard of Oz & Where the Markets Are At Right Now

Dorothy: Toto, I've a feeling we're not in Kansas any more. 


You said it Dorothy!

With that momentary "official" correction (arbitrarily defined as being down at least 10%) in the Russell 2000 now behind us, is it time to finally breathe? I'd like to think so...

Over the course of March and April of this year, investors saw the momo names get taken to the woodshed with NFLX down over 34%, YELP down 45%, and SPLK down over 60% from its highs! Biotechs too. The IBB biotech etf was down 20%. The list goes on. The point is that these prior leaders corrected through price (opposed to to time).

Now, one would expect some retracements in these names as well as in the indices themselves, as sellers become exhausted and/or short sellers cover to book their hefty profits. I think even those with the most bearish views expected some type of dead-cat-bounce in these high fliers (sorry to you cat lovers). Well we didn't just see these minor retracements, but instead we've seen moves in these beaten down names that I think even the most fervent bull is surprised by. The Russell 2000 (IWM) has retraced almost 80% of its down move that occurred earlier this year, NFLX the same story, and IBB has retraced about 24% of its down move. Of course, it's all about perspective; one could look at NFLX retracing over 80% of its down move or could view it from the point-of-view that NFLX is up over 40% from its recent lows. While both viewpoints are effectively the same thing but stated differently, it's clear that things can change rather swiftly.

With all that said, I still recognize that the IWM is still lagging behind the other indices. With SPY up over 5.5% YTD as of this writing, the IWM is hardly up a percent YTD. As the chart below shows, the IWM is actually down relative to SPY year-to-date. This divergence had actually been in excess of 7% but with the recent strength in the IWM, it has come off its lows.

IWM relative to SPY year-to-date

Clearly, there is still relative weakness in this group. But what did you really expect? These volatile, momentum-driven names got crushed on the way down, so could you reasonably expect them to then not only bounce but then outperform the other indices? In my opinion, this is rather normal action.

So what are we to think right now as things stand right now? The wild swings in these so-called "risk assets" may have left some turned around and caught with their pants on the ground. Sectors that led the move during the momo meltdown are currently relatively weaker (on a comparison basis). As you can see from the two charts below, utilities (XLU), energy (XLE), and health care (XLV) are the top 3 performing sectors year-to-date relative to SPY. However, XLU and XLV are actually the worst performing sectors looked at in this analysis for the month of June. Now granted we're only in the second week of June, but I think this represents the recent acceleration we've seen. Industrials (XLI), financials (XLF), and cyclical (XLY) are the top 3 performing sectors month-to-date relative to SPY. Note that XLF and XLY are still the bottom two performing sectors year-to-date. The stark difference in performance of sectors based on different time frames speaks to the fact that sector rotation recently has turned on a dime.

Sector performance YTD relative to SPY

Sector performance MTD relative to SPY

So that brings me to this final point of mine about corrections. I'm sure most of you know that price can correct either through price or through time. Case in point, IWM's 10% "correction" was a correction through price. In contrast, a correction through time simply means the stock, index, or whatever instrument you're looking at is consolidating. This type of correction is actually more bullish of the two, as buyers are willing to support stock/index at what is considered to be extended levels, thereby working off the "overbought" readings. I think this is what we will now see in the market (referring specifically to the SPY). Intermediate indicators are certainly "overbought" but given the broad market participation (% of 52-week highs at levels not seen since March), I think it's more likely we correct through time. It will be interesting to see if the relatively weaker Russell is able to hold its gains as well.

The Daily Show is calling my name now, so until next time.

As always, let me know if you have any questions or comments in the comments box below.

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