MorningWord 5/31/16: Operation Rolling Top

by Dan May 31, 2016 9:53 am • Commentary

Friday afternoon I detailed a trade idea in the XLV, the S&P Healthcare Select etf (read here).  The premise was fairly simple. The XLV has been a relative under-performer but it could be poised to play catch-up.  The index is down about 1% on year, and down about 9% from its 52 week highs. vs the S&P 500 (SPX) which is up 2.7% on the year, and down about 1% from its all time highs made last May.

35% of the etf’s weight, (the top 5 holdings) are down about 3.5% from their 52 week highs on average. But here’s the part that could set up for the catch-up trade. The number 5-10 largest holdings in the etf, which make up about 20% of the etf’s weight are down on average 17.5% from their 52 week highs.  If the SPX is to make a new high, I suspect a sector like healthcare, and specifically the beaten up biotechs among them, would be a major beneficiary of traders looking for beta.

I discussed this trade idea on Friday’s Options Action on CNBC:

But this morning I want to revisit the lede of the post as it pertains to the broader market.

Tuesday morning, right before the S&P 500 (SPX) ripped 2% in a straight line into today, I offered a quick take on the technical set up of the index using a few time-frames (MorningWord 5/24/16: Fool Me Twice? – $SPX). To be clear, I have taken a less than sanguine view of the price action of the largest stock market in the world for more than year and a half, and specifically. I’ve been focused on the two lower lows since the May 2015 all time highs, and most specifically, the February low, which was the first lower low in the index since the start of the bull market in March 2009.  On Tuesday’s Fast Money on CNBC, I did say that the one thing that would change my mind would be a new high in the SPX, followed by a new base above the prior high, thus establishing a new range.

This morning I was locked out of my office for a bit, and was doing a little work on my iPhone and the chart of the SPX on my Bloomberg Anywhere app looked very different than the charts that I draw on that come to life of my desktop through my $25k a year Bloomberg terminal, and I tweeted the following:

The point here is simple, if I didn’t know that chart was the largest equity index in the world that has shown remarkable relative strength to every other equity index in the world over the same time period, I might consider buying it. But knowing what I know about global growth, and just how fragile our own economy is, with the SPX less than 2% from its all time highs, I have a hard time buying this breakout.

But maybe there are some potential breakouts I can get behind.

Not to put too fine a point on this, but its been my belief that the SPX has been making a rounding top, and that the two lower lows in the equity index since last May, and importantly the first lower low in the index since the start of the bull market in March 2009 back in February signaled the beginning of the end.

Since that’s largely a technical call, I need to stay disciplined and not move the goal-posts. If that technical view is blown out of the water by the index establishing a new range above the prior highs, then that needs to be respected.

But there’s a second component to my bearish thesis at these levels. And if the fundamentals don’t get better, new highs won’t be given too much credence for the reasons why new highs are made.

For instance, if the U.S. Federal Reserve does NOT raise interest rates at their June meeting (Fed Fund futures are currently predicting a 28% probability, the lowest in a week, while the July probability sits at 47%) that may be bullish for equities n the short term, but not really bullish for the global economy. Investors would once again be buying stocks simply because there is no alternative to stocks (T.I.N.A). So while I need to be respectful of my technical call and not move the goal posts if a new range higher, investors should also be aware of moving the goal posts on growth expectations.

A push out of rate hike sin my mind is NOT bullish for anything, but I am not blind to the fact that global investors looking for return have turned into nothing other than lemmings, and in that environment, I will spend most of my time and investible capital on micro moves of single stocks or sectors, and less so on indices like the SPX.