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Areas Of Strength In Today’s Volatile Global Markets

So far, 2022 has not been kind to US investors. The year began with a massive spike in Covid cases domestically caused by the Omicron variant. Then, something happened that many investors thought they would never see again: a major land war broke out in Europe as Russia invaded Ukraine. Adding to the woes, inflation has remained at elevated levels, with the most recent Consumer Price Index posting a 7.9% increase year-to-year. Finally, the US Federal Reserve has begun to raise interest rates, with a 25-basis point increase in the fed funds rate on March 16.

All of this has caused US equities to retreat, with the S&P 500 down 8.6%, the Nasdaq down 14.11% and the small cap index, the Russell 2000, down 9.4% year to date, as of the close of markets on March 16.

In general, the investment environment has been tough globally. Due to strong year-to-date gains in commodity prices, especially oil, natural gas, copper, nickel, and gold, the global stock markets that have performed the best are those heavily weighted towards commodity producers. Furthermore, because those economies benefit from rising commodity prices, the gains can be seen across other areas, including financials and, in some cases, even consumer/retail areas. The worst markets are the formerly leading and growth-orientated markets, particularly the technology-heavy markets of the U.S., South Korea and China. More recently, due to heavy reliance on imported energy and the previously mentioned war, most European markets have weakened dramatically.

The table below ranks the best and worst global markets/regions so far in 2022. The performance is stated in U.S. dollar terms using U.S.-traded ETFs as proxies for the overall market. This is even more interesting to examine because the U.S. dollar has been sharply up this year. In general, this has hurt foreign market performance in U.S. dollar terms. However, some leading markets’ currencies (usually tied to commodities) have held up well vs the U.S. dollar.

In particular, we like two areas that are not discussed much but have been leaders this year: South Africa (+27% vs S&P 500 YTD, with the South African rand +5% versus the dollar) and Southeast Asia as a whole: Thailand, Singapore, Indonesia, Philippines, Malaysia, Vietnam, where currencies range from flat to -2% versus the U.S. dollar). Of course, there are not very many ways for U.S. investors to gain exposure to these markets outside of a few large-cap ADR listings. However, broad exposure through ETFs such as iShares MSCI South Africa (EZA) and Global X FTSE Southeast Asia (ASEA) is simple enough. Weekly charts for each are shown below, and we would place heavy emphasis on their lack of overhead in terms of % off 52-week highs, as well as sharp relative strength line uptrends (bottom green line on each chart, versus S&P 500).

For those only interested in the U.S., in the table below, we highlight some of the best and worst market segments year to date in the U.S. market, excluding commodity orientated stocks.

One favored area that has held up very well, and is not purely defensive, is US infrastructure. The US Infrastructure Development ETF (PAVE, shown below) has minimal overhead and is back above the 40-week moving average (WMA) and in a strong position to lead whether the market continues to struggle or begins a new uptrend. During the historic market rally from the 2020 lows through early-2021, it was one of the leaders. Unlike other leaders during that time (software, small-caps, IPOs, biotech), its relative strength line is back to all-time highs. The recently passed US infrastructure bill is a likely catalyst for this strength as the funds allocated to it begin to be spent. Leading names to look at include Quanta Services (PWR), Aecom (PWR), Reliance Aluminum & Steel (RS), Union Pacific (UNP), and Evoqua Water Tech (AQUA).

Despite the sizeable rally this week, we would continue to avoid the Chinese market until a more consistent technical pattern emerges. Of note, bear market rallies are frequently more explosive than bull market ones. The extreme moves this week make us question the sustainability of China’s current rally, especially since it is occurring without what we consider a classic positive technical setup. Rather, it would be our preference to reduce exposure by selling into this current bounce. From an investment strategy standpoint, we would rather buy into a market that has stabilized, even if it is at higher levels, than try to predict a bottom in Chinese stocks. The weekly chart of the iShares China Large-Cap ETF (FXI) is shown below.

With regards to the previously high-flying US software group, as represented by the ETF IGV and shown in the weekly Datagraph below, a significant amount of technical damage has been done. Relative strength is near a three-year low and the group has broken two key support levels. Presently, from an O’Neil perspective, the group will need time to form a proper base. It is important to note that many leadership groups in prior bull market cycles have not come back to outperform the broader market or have taken years to regain leadership status. As a result, we prefer to see software stocks rising above their moving averages and technical overhead supply before allocating a large amount of capital to the group.

With regards to semiconductors, represented by the SOXX ETF, the group appears to be at support though is still trading below both its 10 and 40 WMA. Former leaders like Nvida (NVDA), Advanced Micro Devices (AMD), ASM Lithography, and Qualcomm (QCOM) need time to repair their recent damage and, like software, work off their overhead supply. However, some semiconductor stocks are forming better technical formations, including Broadcom (AVGO), semiconductor equipment manufacturer Axcelis Technologies (ACLS), Pure Storage (PSTG) and former leader Rambus (RMBS).

Finally, the broader US market is trying to rally. On March 16, the S&P 500 experienced a Follow-Through Day (FTD) on day 15 after the recent low by rising 2.2% on higher volume than the previous day. This is the second FTD to have occurred in this 2022 market decline. While bullish, normally in a bear market, indexes will have numerous FTDs before finally beginning a sustainable rally. In our view, it will be necessary for yesterday’s FTD to be sustained to avoid a more prolonged bear market scenario.

For the 66 prior FTDs on the S&P 500 since 1970, which occurred after a price decline of 9% or more from the highs, and with the market trading below its 40 WMA, the normal timeframe was for them to occur on day 6 or 7 after the previous lows. There have been seven FTDs that took place more than 15 days after the previous low.

Of those, one was the second FTD after the first one had failed:

  • July 1985-Day 32 FTD: this was the same day the market broke into new highs. There had been a 1.7% gain early on, but on just day 3. This does not meet the O’Neil criteria of a FTD four or more days after the market low. The 3-month maximum gain was 9%.

Three FTDs occurred in bear markets:

  • Sep. 1973-Day 19 FTD: 3-month high after the FTD was +7%. However, the market undercut its lows two months later.
  • April 1978-Day 32 FTD: this FTD actually marked the ultimate bear market low after four prior failed FTDs. The 3-month high was +10%.
  • August 1982-Day 18: this FTD failed and undercut within a few days. Another FTD quickly occurred thereafter that marked the end of the bear market. The 3-month high was +30% and the beginning of a long secular bull market.

Unfortunately, none of these prior setups look similar to now. Also, given the lack of data points, it is hard to draw a firm conclusion. We encourage investors to remain open to a continued rally given the FTD, but to focus on the areas of relative strength and remain cautious until clear evidence of a sustainable uptrend emerges.

Co-author statement:

Kenley Scott, Research Analyst, Director, Global Equity Research, William O’Neil + Co., made significant contributions to the data compilation, analysis, and writing for this article.

Disclosure:

No part of the authors’ compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed herein. O’Neil Global Advisors, its affiliates, and/or their respective officers, directors, or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein.

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