Chart Advisor: The FOMC Hits the Brakes

By J.C. Parets & All Star Charts

Wednesday, 14th June, 2023

1/ Stocks Brace for Rising Rates

2/ Markets Scream Risk On

3/ Sector Rotation

4/ Airlines Catch Flight

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1/ Stocks Brace for Rising Rates

The Federal Open Market Committee (FOMC) hit the brakes today, deciding not to raise the target rate for the first time in over a year.

While it’s impossible to say with any conviction what lies ahead for U.S. yields, one key intermarket ratio provides critical insight.

Check out the ratio of regional banks (KRE) relative to REITs (IYR) in the lower pane with the U.S. 10-year yield in the upper pane:

The classic relationship between these markets has decoupled from a structural trend perspective (rates higher, KRE/IYR sideways). However, they continue to post significant peaks and troughs in tandem.

Also, notice how KRE/IYR is bouncing off levels that coincide with its 2016 and 2020 troughs. (Both were excellent times to buy stocks.)

A sustained rally in KRE/IYR ratio would suggest that the stock market is ready to handle the rising rate environment, whatever that entails for yields—sideways or higher.

2/ Markets Scream Risk On

As stocks continue to rally, we seek confirmation of the recent strength from risk appetite indicators.

One way to do it is through the discretionary vs. staples ratio (XLY/XLP), which gives us excellent information on market participants’ positioning.

As you can see, the ratio has been accelerating in the past few weeks, and it’s threatening to break out of a one-year base.

Looking more closely, it is achieving its highest level in a year this week, which supports the recent rally in the stock market.

Bulls want to see this ratio make a decisive resolution from this base, as this offensive positioning would support higher prices for risky assets in the future.

3/ Sector Rotation

They say that sector rotation is the lifeblood of a bull market.

One way to visualize this theme is by looking at the bubble chart below, as it shows the two-week performance on the Y axis and the year-to-date return on the X axis for a handful of large and small-cap sector ETFs:

As you can see, technology (XLK) and communications (XLC) have booked a solid gain this year but have lagged over shorter time frames. The opposite is true when we look at the value-oriented sectors, which have performed the best in the past two weeks.

While this bubble chart illustrates relative strength from the weakest groups over shorter timeframes, the more important takeaway is that all of these sector indexes have been moving higher in recent weeks. This is the kind of expansion in participation that could fuel the stock market rally higher.

4/ Airlines Catch Flight

With sector rotation running its course over the past few days, a group that has shown impressive strength is airlines.

Below is the NYSE Arca Airlines Index reaching new 52-week highs:

Last week, price emerged from a one-year base, experienced bullish follow-through, and has been accelerating higher ever since. 

Not only is the 200-day moving average curling up, but momentum, as measured by the 14-period relative strength index (RSI), is achieving its highest level since early 2021.

The fact that this lagging group is making fresh highs speaks to the relentless bid for stocks this year. This is a characteristic of bull markets.

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Originally posted 14th June 2023