No matter how long you’ve been in the business, no matter how many corrections or pullbacks you have seen, days like today are always a bit spooky. The hot unemployment numbers from today (8/2) gave investors a concern that the odds of a soft landing might not be as high as markets had hoped for. The VIX, or “fear gauge” as some call it, spiked over 50% intraday as investors geared up for further uncertainty. Small caps, which were previously lifted higher on the idea of September rate cut found themselves getting hammered with intraday action. This, of course, comes at a time when markets were looking for any reason to pile onto the small cap train as market breadth was improving as we opened August. But the point of today’s piece isn’t to talk about small caps… let’s let the dust settle there before any calls are truly made. The main focus for the WYA is simple: To help cut through the noise as clients see red in their portfolios.

To start, let's take a look at what the month of August brings markets. The chart below walks through average market returns for each calendar month. We have touched on weakness during the summer months, with August bringing in below-average returns historically. Dating back to 1987, SPX has posted an average return of -0.67%, only beating next month- September historically. Minimum/Maximum monthly readings are also less attractive than the “normal” months. All this to say- remember we are in a seasonally weak part of the year. While the magnitude of August's pullback so far has been intense- if there was a time of year for it to be more “normal”, now would be the time for it.

With intraday action, SPX will also post its first sell signal since October of 2023 on its default chart. It may seem like common knowledge- but markets can’t go up every day. Pullbacks are normal, exhales are normal, and yes, even “sell” signals are normal from time to time. Now, those aren’t excuses to fall asleep at the wheel… but simply a reminder that swift exhales within an overall strong market uptrend are nothing to pull the emergency exit over. To close, we will offer a few things the analyst team has their eye on as volatility does pick up:

            - 1 sell signal is “normal”, but a series of lower tops and sell signals could be more concerning for broad markets. Watch SPX around old resistance at 5,250.

            - Small caps and the longevity of their rally. If the space falls, market breadth should narrow, a net negative.

            - The strength of the “core.” Perhaps zooming out of solely technicals, if the economy is unable to achieve a soft landing, what areas emerge as relative strength leaders?

As clients call in and question where their portfolios are positioned, remember that part of the job is helping calm panic as markets ebb and flow. While there are elements of the markets that are definitely eye-catching (and could be concerning if we see further downside action…) domestic equities remain in control. Make sure to use the alerts manager to keep track of notable charts easily.

As discussed over the past few weeks, market breadth has materially improved, and the real estate sector is showing signs of life for the first time in a long time. I searched our archives to find the last report where the sector was discussed positively but came up empty handed. Three reports that did turn up are linked below:

• Real Estate Looks Different on Wall Street
• The Real Estate Struggle Continues
• The Real Estate Rodeo

There were plenty of rallies in the last two years, but none had the magnitude or endurance to pull the sector out of the basement rankings on our macro indicators. To that point, real estate funds have consistently carried one of the lowest average scores on our Asset Class Group Scores Page. However, the tide may now be changing. Earlier this week the real estate group score breached 3.0 which is a significant milestone and threshold for technical health. Granted, most other sectors still have higher scores; nonetheless, this is a big step in the right direction. The last time real estate moved into the 3.0 score zone was March 2021.

Note: This is a technicality, but important - the real estate group was most recently above the 3.0 score in May 2022, but it was on a downward trend, not an entrance/uptrend like we see today.

Earlier this week we also saw the Real Estate Select Sector SPDR Fund (XLRE) move into a column of Xs against our cash proxy (MNYMKT) on a 3.25% relative strength chart. In common speak, this means that real estate has recently outperformed cash by about 10% (3.25% box size x 3 box reversal = 9.75%). Remember that our cash proxy, MNYMKT, is the 13 Week Treasury Bill which has been no slouch as of late with short-term yields hovering around 5%.

Interestingly, XLRE is now the closest to giving a relative strength buy signal in over two years - roughly 3.25% further outperformance will do the trick. The last time XLRE printed a relative strength buy signal against cash was February 2021, but the last time XLRE returned to a relative strength buy signal was June 2020. Admittedly, the signal history on the chart below was inconsistent prior to 2020, but since then the chart has trended nicely (signals leading to further signals of the same kind).

What changed? In short, interest rates, and more specifically, the expectations for interest rates. The relationship of interest rates and real estate is 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.” So, with the market looking for a cut in September and an accommodative monetary policy thereafter, perhaps real estate has some breathing room.

Another factor likely being weighed is the soft-landing probability. The real estate sector is not a traditionally defensive play, unlike utilities and consumer staples, which means that investors would likely not hang around if rates are crashing in the face of an economy falling apart. The jury is still out on this topic, and likely will be for a while, but it is still worth acknowledging.

For those with a strategic mandate to have real estate exposure, or those wanting a more opportunistic/tactical approach, we have emphasized for years that only focused exposure was justifiable. In other words, very few (if any) broad real estate funds were demonstrating healthy technical behavior, forcing investors to take a more tailored and/or individual stock approach. While that is largely still true today, we have seen some broad funds pop on the radar.

The XLRE trend chart has improved materially. With a fund score comfortably north of 3.0 and December 2023 resistance in the rearview mirror, the technical picture has brightened. Further bullish confirmation would come with a push past the February 2023 highs at $42. RSPR, the Invesco S&P 500 Equal Weight Real Estate ETF (RSPR), is another example with a fund score now above 3.0. It would be ideal to see RSPR clear its February 2023 highs; regardless, it is a good sign to see the largest (XLRE) and average (RSPR) real estate stocks putting up good performance.

Portfolio View - Major Market ETFs

Featured Chart: Invesco QQQ Trust (QQQ) vs Invesco S&P 500 Equal Weight ETF (RSP)

QQQ continued its pullback as it gave its first sell signal in 2024 and tests support at the $445 level. Despite its recent fall, QQQ still holds a more than respectable 4.55 fund score. The fund was previously in extended territory, and the abrupt pullback during Friday's trading leaves the fund slightly in oversold territory 

That said, the fund has lost some relative strength versus other names, underperforming  RSP by over 10% in the last four weeks. QQQ reversed back into a column of O's against RSP on a 3.25% relative strength chart during last week's trading, showing near-term weakness against the equal-weighted S&P 500, but would need significant further underperformance to hit a sell signal. QQQ still holds a better long-term picture, but keep an eye out for further deterioration as a sign of continued tech-focused weakness. 

Additional Comments:

The majority of the funds within the table above moved lower this week. EFA, QQQ, and XLG returned to sell signals on their default charts, signaling some weakness on the international front and within the large cap core. Small caps have also been in focus, seeing IJR reverse to old resistance from earlier this year. As market volatility picks up, continue to monitor these areas of the market with a watchful eye. 

Daily Option Ideas for August 2, 2024