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The Welcomed Pullback; Defensive Sector Shift

The market has begun the pullback we noted in our 1/22/20 US Macro Vision. At the time, the S&P 500 was extended over 10% above its 200-day MA while the Nasdaq Composite extended over 14% above its 200-day MA, something that has happened less than 10 times over the last 20 years for each index. We also noted prior instances of these indexes reaching similar extended levels often resulted in sideways consolidation or a 5-10% pullback. Peak to trough declines are currently in the 3-4% range, meaning it is possible the worst of the declines are behind us. As we highlight below there has been some indicator deterioration, however longer-term trends remain constructive. Continue to buy the dips.

  • Sector Relative Strength Rankings & Weighting Recommendations. We are upgrading Consumer Staples and Utilities to market weight due to bullish price and RS reversals. We consider RS improvement for these defensive areas as part of the aforementioned “indicator deterioration,” however some outperformance from defensives within a broad-based bull market is not unheard of, particularly in a low-rate environment. Additionally, we are downgrading Manufacturing (to market weight), Energy (to underweight), and Materials (to underweight).
  • Indicator Deterioration, NOT Derailment. Several indicators have deteriorated, signaling the potential for lower economic growth. Deteriorating indicators include copper, copper vs. gold, the 10-year Treasury yield, WTI crude oil, high yield spreads, the US dollar, and the small vs. large-cap ratio. At the same time, we have reason to believe the moves in these indicators are closer to their end than their beginning, meaning a reprieve for the equity market may be forthcoming.
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