Energy, Yield Rally Correlation Faces Unwinding Risk as SPX Market Breadth Wanes

SPEAKER_1 (0:00)

Welcome back to Morning Trade Live. It is now time for the big pictures. Let's welcome in Rachel Dashiell, Head of Technical Research and Strategy, Schwab Center for Financial Research. Good morning Dash, thanks so much for joining us today. So we've lost 7,700 on the S&P 500 this morning, as we do have yields and oil pressuring equities. What levels are you watching today?

SPEAKER_2 (0:20)

Yeah, good morning. And yeah, you're exactly right. So the S&P 500 broke out of this descending channel, and you see volatility just became more and more compressed, and really we're reaching the tightest level that the Bollinger Bands have shown all year. So the levels I'm really watching, especially this morning, was that prior gap level around 76, or 77.6 to 76.90, which we see was kind of penetrated this morning, but not fully closed. So I would say Bulls would argue that this level really does need to hold, because any gaps that are filled within around four trading days or so are an indication of exhaustion gap. So I think if you see that occur and you see that close below this gap right around 77.60, you know, you may see additional volatility in the market with a shakeout back towards prior support around 7,600.

I would say though, digging a little bit deeper under the surface, the S&P has held up quite well, despite all the bad breath that we've had in the market. So if you look at the New York Stock Exchange, new yearly lows, which is that measured of breath that tends to spike during corrective periods, it's really spiking to the highest level seen all year, which is interesting given that we're about 2-2.5 percent away from all time highs, and it typically spikes during market bottom. So I think when you hear about weak market breath, it makes sense to put it in the context of the sector trends that we're seeing, and we're seeing technology break out, relatively the S&P and staples and utilities and other defensive groups hitting new relative lows.

SPEAKER_1 (1:53)

Yeah. What do you make of that? Because it's been such an interesting summer of rotation, where we did see this underperformance of the Mag-7 to quickly now the outperformers this week with this breakout record highs for the cohort earlier on Monday and Tuesday, and really reestablishing that market leadership.

SPEAKER_2 (2:14)

Yeah, I think it's pretty notable, especially because, you know, in early bull cycles, tech seems to lead, and, you know, we just went through another shorter cycle of, you know, bad breath, washout levels, and now we're kind of seeing tech step in and take the lead again. And tech really takes up almost 40% of the index. So when you have the leaders back into the game after the market has just been carrying itself higher by the rest of the market and some of these other groups this entire time, when you have a leadership group like that, kind of steps back into the lead, this could carry the market a lot higher for right now.

SPEAKER_1 (2:54)

Yeah, absolutely. And talk to us about energy, what you're seeing as far as that sector lending support.

SPEAKER_2 (3:00)

Yeah, so the energy sector, just following some short term weakness in crude oil has tested this confluence of support from prior highs in the 50 day moving average. And traders really haven't seen that confirmation of a bounce here from energy yet. So they may be looking for a close above the high of the low day as an example of confirmation to add to positions on weakness here within the energy sector. But something I think a couple of things notable is, you know, looking at the Bollinger bandwidth volatility, it's compressed to some of the lowest levels that we've seen all year. And typically we say that volatility is mean reverting and it can accompany price breakouts in either direction. So I think that's what traders should be keeping their eye on. And the other thing is some correlations that I am seeing between the energy sector and 10-year yields. So the rolling three-month correlation has reached this very strong positive extreme of 0.9, which typically when correlations kind of reach these extremes, they have these habits of unwinding and they change with these dynamic market conditions. So I would kind of wonder, and maybe other technicians would too, if this remains such a tight relationship as crude oil and energy sectors really test some of these key levels. But I think the bigger picture and the bigger question here is, you know, Sam, do we have energy prices and yields that continue to move up with stock prices? And I think yes, you know, we've seen all year that yields have moved higher and so have stock prices. And there's been historical times where this has occurred, where we had inflationary times, commodity booms and, you know, the energy sector has been a higher weight in the overall index. And that may be something that we start to see here, especially if the strength continues. So I definitely think it's something that investors should keep their eye on.