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Vermilion Compass: Weekly Equity Strategy

Breadth is waning – there's no question about that. Yet selling appears to be discriminate, so far, as if there's a reason behind which stocks get hit, not the indiscriminate “sell-button.”

But even with waning breadth, the weight-of-the-evidence still supports further upside. And combined, these two factors favor stock-pickers. Our top-down and bottom-up observations support this. Looking through Sectors and Groups, we find stocks with attractive set-ups neighboring those with deteriorating technicals. For instance, in our Life & Health Insurance Group, AFL is pulling back to support while PRU exhibits a possible, multi-month top. In Large-Cap Tobacco: PM is a buy at support, MO is a sell following a trendline violation. In Banks: BK looks great, less so for CFG (and many small-cap names).

In short, assuming the market's long-term uptrend continues – our stance – this dip in breadth is a favorable sign for stock-pickers, creating an environment where selectivity can aid in outperformance.

With that in mind, there's still plenty to like about this market, technically speaking:

• Tech continues to lead. Its tenure remains intact. And XLK's relative strength uptrend sits just below all-time highs. If this market was rolling over, leadership should exhibit swift breakdowns in relative strength. Not so... see page 3.

• Foreign markets look great. Of course, they are benefitting from a slow rotation out of the U.S. But again, if the U.S. is rolling over, we wouldn't expect to see the MSCI Emerging Market Index break out above a 10-year resistance level to all-time highs. That's definitely a sign of risk-on ... see page 3.

• Many cyclical Groups remain attractive. Casinos are Exhibit A. Names like LVS, WYNN, MGM, MLCO, and PENN have pulled back to base support levels. (Hong Kong-listed Macau names look good too.) Other Groups holding up well include: Homebuilders (DHI), Chemicals (FMC), Miners (FCX), Asset Managers (despite pullbacks; STT), Truckers (KNX), Semis (TSEM), Software (VMW), and Biotechs (GILD), where recent pullbacks have created opportunity. Also, though still a laggard, Retailers, surprisingly, are exhibiting latent strength in the form of improving internals; the % of the SPDR Retail ETF's (XRT) holdings trading above their 50-day MA is bullishly diverging with the fund's price downtrend -- typical action near a low. In today's report we highlight actionable charts within these Groups.

Going forward, we continue to monitor events that could derail our outlook. Chief among these are: (1) major indices violating support; (2) the Financial Sector breaking down to 52-week lows; (3) foreign markets rolling over; (4) relative strength breakouts in defensive Sectors (this is partially visible in Utilities, though we saw a similar attempt that failed earlier this summer); and (5) relative strength breakdowns in leading Sectors like Tech.


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