Concern around the Chinese economy led shares in Hong Kong lower this week, as the Hang Seng Index HSI-HK fell -5.89% over the past five days to drop into bear market territory. On Thursday, China Evergrande Group, one of the largest property developers on the Mainland, filed for Chapter 15 bankruptcy in New York, which would allow bankruptcy proceedings to move into effect for the three Evergrande companies based in Hong Kong, the British Virgin Islands, and the Cayman Islands (source: wsj.com). This move was also paired with further stress from Zhongrong International Trust, an asset manager in China that had around $108 billion in AUM at the end of last year, as the privately held company missed interest and principal payments to publicly listed companies in China totaling $14 million (source: wsj.com).

The Hang Seng Index dropped over 2% during the market action on Friday, pushing HSI-HK down below the 18,000 level on the longer-term focused 200-point chart for the first time since November 2022. The Index has now declined 20.88% from its recent peak of 22,688 seen on January 27, initiating the 27^th bear market we have seen since our index data began in 1982. The average decline from each bear market sits at almost 34%, which is directly in line with the peak-to-trough move in the last bear market from April 4 – October 31, 2022. The current decline sits at 203 days, which is longer than the average bear market period of about 166 days. The Hang Seng has averaged just over 60 days from the date of each 20% decline to the ultimate trough in each period. Of course, some of those declines saw an abrupt end to the weakness as soon as the 20% threshold was breached, as we saw in 2004, 1992, and 1989. Others saw extensive weakness, highlighting the potential for further weakness.

The 200-point chart of the HSI-HK broke through support from May of this year at 18,200 this week after returning to a sell signal at 18,400. This move also pushed the index back into a negative trend. In July, we saw a brief resurgence from the Hang Seng, as the index broke a triple top before failing to break through further resistance at 20,200. The inability of the index to break through key resistance points this year does not bode well for the relationship between buyers and sellers moving forward. Weekly momentum also just flipped negative, suggesting the potential for further downside from here. Initial support on the longer-term focused 200-point chart can be seen at 17,000, which would be another 5% drop from current levels. Additional support may be found at 16,000, which would mark a 10% further decline, with the 52-week low sitting down at 14,600.

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Housing and Real Estate are a cornerstone of how we all live our lives. At least for the recent past, the same cannot be said for helping out our investment portfolios, which have been best suited to steer clear of the sector. We have touched on this throughout the past 12 months as the group has persistently posted low relative strength readings across the platform; currently, Real Estate holds an average fund score of only 1.61 and earns a pitiful 47 buy signals within the DALI sector rankings. Individual stock picking has been just as difficult, with few representatives holding what the analyst team would consider acceptable ratings from a technical perspective. With knowledge of this historically bad run on the back burner, today’s report will focus on other instances of such underperformance in hopes of identifying what may be in store for the group in the near future.

To do this, we ran a performance spread between the S&P 500 (TR.SPXX, which assumes dividend reinvestment) and the MSCI US REIT Total Return Index RMSG. By nature of the business models behind the sector, Real Estate can often take on the “income” focused role within a client’s portfolio. For this reason, dividends were included in today’s analysis to allow each group to play on a level field. Even with dividends included for RMSG, rolling 1-year performance for the index is underperforming the broad S&P 500 by a wide margin, nearly 17.50% at the time of this writing. Looking at the chart on the left, this seems to be encroaching on a rather historical mark, with outperformance in favor of TR.SPXX topping out around 23% five times over the last two decades. While history seldom repeats it often rhymes, suggesting that further underperformance from the sector in comparison to the broad market would be quite rare.

On the other side of the conversation comes homebuilders, which have continued to rocket forward as the demand for new builds remains strong from a macro perspective. A similar 1-year performance spread between the SPDR S&P Homebuilders ETF XHB.TR and RMSG was run, revealing a similar picture to the one discussed earlier. Outside of the strong showing (100%+ outperformance in favor of XHB.TR) in 2020, the rolling 1-year performance spread is at somewhat historic levels. All this considered, the performance spreads suggest a near-term uptick (or at least stabilization) could be due for this washed-out sector.

As for why Real Estate is underperforming to this degree, that is generally outside of our lane as technical analysts; however, we can say that interest rates have historically been a good indicator. Before delving into this relationship, note that many Real Estate names traded in the marketplace (and underlying popular equity ETFs like XLRE) are Real Estate Investment Trusts, REITs for short. These investment vehicles pool capital from numerous investors to purchase and operate income-generating Real Estate. The trust is then required to distribute at least 90% of its taxable income in the form of shareholder dividends each year, which will often translate to high dividend yields for investors. A REIT is publicly traded, which brings liquidity to a traditionally illiquid asset class and will often specialize in a certain type of property such as hotels, shopping malls, etc. In addition to the payout requirement, REITs can also offer potential tax benefits and diversification to an investment portfolio.

So, given this background, rising interest rates can undoubtedly impose some headwinds for REITs. Summarized well by S&P Global, “All else being equal, higher interest rates tend to decrease the value of properties and increase REIT borrowing costs. In addition, higher interest rates make the relatively high dividend yields generated by REITs less attractive when compared with lower-risk, fixed-income securities, which reduces their appeal to income-seeking investors.”

We will conclude today with a relative strength chart between the Invesco S&P 500 Equal Weight Real Estate ETF (RSPR, formally known as EWRE) and the S&P 500 Equal Weight (SPXEWI). In question form, this chart answers, “How is the average Real Estate stock faring against the S&P 500?” We partly know the answer based on the spreads first discussed in today’s piece, but this chart adds further perspective from a cumulative point of view. As we can see, the record lows from March 2009 are not far off; in fact, we are only about 10% away. Although we do not call past lows on a relative strength chart “support” or past highs “resistance” as we would on a regular trend chart, they can still be notable areas of market memory – especially in this case.

Extreme underperformance can certainly go on longer than anticipated, and the overall technical trend is still against the Real Estate sector currently. However, as trend followers we must also be mindful of potential mean reversions; the longer this trend of severe underperformance persists the more intently we (and others) will likely be watching.

Portfolio View - Major Market ETFs

Additional Comments:

The SPDR Dow Jones Industrial Average ETF Trust DIA remains in a column of X’s this week, sitting at $355. The fund remains on its second consecutive buy signal on the default chart. The fund now scores just below an acceptable score, scoring at 2.99. It still scores below the average US score of 3.52. DIA remains in a positive trend at current levels. Support is offered at $315 with overhead resistance at current levels.

The iShares MSCI Emerging Markets ETF EEM remains in a column of O’s this week, seen at a price of $38.50. This will move the fund back into a negative trend for the first time in 2023. With this in mind, EEM now scores below the acceptable 3.0 threshold with a score posting of 2.67, falling behind developed markets representatives. The fund sees initial support at $38, with more substantial support down around $37.

The iShares MSCI EAFE ETF EFA returned to a column of O’s this week, returning to test nearby support at a chart reading of $70. Developed markets have deteriorated slightly, now shown by a positive, but weakening 3.65 fund score. The ETF remains in a positive trend at current levels with established support offered at current levels. Overhead resistance is now found at $74.

The iShares MSCI Frontier and Select EM ETF FM returned to a column of O’s this week, seen at a chart reading of $26.50. It remains on a buy signal after posting new 2023 highs to end July. The fund has a strong fund score of 4.04 and is now paired with a positive 2.59 score direction. Support is seen below at $24.50.

The iShares S&P MidCap 400 Index Fund IJH returned to a column of O’s this week, seen at a chart reading of $255. However, the fund maintains its position above the bullish support line. IJH has a current fund score of 4.06 which is now above the average US score of 3.52. From here, overhead resistance is found at $270 with the bullish support line found below.

The iShares S&P SmallCap 600 Index Fund IJR remains on a buy signal this week but did return to a column of O’s on its default chart to a price of $98. Despite the recent action leading to now 3 consecutive buy signals, IJR maintains an improved, but still unacceptable 2.36 fund score. Support is offered below at $97, with overhead resistance found at $104.

The Invesco QQQ Trust QQQ remains in a column of O’s this week, continuing the pullback from growth-focused areas. The fund is now seen at a price of $355. With that said, the fund still holds a strong 4.71 fund score and is paired with an intensely positive 2.18 score direction. This now outpaces the average US fund, which shows a 3.52 average score. Initial support is offered at $290, well below current levels.

The Invesco S&P 500 Equal Weight ETF RSP reversed down into O’s this week, now seen at a price of $146. RSP holds a negative 1.89 score direction and now displays a 3.57 fund score. This is still behind the average S&P 500 Index fund score of 4.50. The spread between the two has solidified around current levels over the last few weeks. Support is now seen at $140.  

The SPDR S&P 500 ETF Trust SPY returned to a column of O’s this week, now seen at a price of $435. The fund holds a strong 4.17 fund score, besting the average US fund score of 3.52. May’s action saw the fund return to a column of X’s against SPXEWI suggesting near-term strength for the cap-weighted names. Support is seen at $385 on the default chart, March lows.

The Invesco S&P 500 Top 50 ETF XLG returned to a column of O’s this week, seen at a chart reading of $34.50. The fund remains on a string of now three consecutive buys signals, suggesting strength from larger names. Furthermore, XLG now has a near-perfect 5.61 fund score with a now positive score direction of 3.54. XLG scores above the average US Fund of 3.52. Support is seen at $28.50 on the default chart, notably below current levels.

Daily Option Ideas for August 18, 2023