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Vermilion Compass: Weekly Equity Strategy

SPX Testing Resistance as Rate Cut Cycle Begins

The S&P 500 (SPX) is back to test YTD highs and important resistance in the 5670-5783 range. This is an important target/resistance area we have discussed for weeks; using the 2007 SPX topping analog which has tracked the current market almost perfectly, it would suggest a 2% or less move above the prior all-time high set in July at 5670 before topping, which is where we get the 5783 number. As long as the SPX does not have a weekly close above 5783 we continue to recommend reducing risk and shifting to defensives, and this is the ideal time to do so. Tops are processes; 2000 and 2007 tops consolidated for 5 to 6 months before ultimately breaking down. We initially discussed expectations for a 1- to 4-month pullback/consolidation period on the SPX and Nasdaq 100 (QQQ) in late-July (7/30/24 Compass), but as discussed last week (9/10/24 Compass) it seems likely to last closer to four months, and potentially 4- to 6-months from the 7/17/24 starting point, until the market decides which way this consolidation resolves. For now, we remain neutral on the SPX, preferring to sell near 5670-5783 resistance and buy near 5100-5200 support until there is a break in either direction.

FOMC Rate Cut Cycle Begins Today. Since our 7/30/24 Compass we have made it clear that we believe the Fed is behind the curve on rate cuts. Therefore, we expect a 50bps cut (63% odds) to be well-received, while a 25bps cut (37% odds) could be seen as the Fed "not doing enough." What it will ultimately come down to in terms of SPX continuing higher or suffering a larger correction, is whether or not this rate cutting cycle is accompanied by a recession or not. Rate of change recession indicators such as the Sahm rule and Schannep Recession Indicator recently moved even deeper into "recession zone," but most economic data remains non-recessionary on an absolute basis. We continue to be open-minded.
Big Picture Trends. The Dow, RSP, XLB, and XLI are back to test YTD highs as they likely await today's FOMC announcement for direction; last week we discussed how they looked like failed breakouts, but they are really just consolidating. Defensive Sectors (Utilities, Staples, Health Care, and Real Estate) continue to be leadership, a clear risk-off signal; we have not seen defensive Sectors outperform like this at any other time in over two years. Additional concerns: WTI crude oil displays a major breakdown below $71 (a recessionary signal) and most indexes are below resistance with many forming potential head-and-shoulders tops (e.g., SPX, QQQ, SMH, XLK, IGV, IPO, XLC, ARKW, VXF, IJH, IJR, IWM, XRT, XLY, XBI, PSCH, XLB, KBE, and EEM)... see chart below and pages 2-5.