Market Retreat and the Relationship Between Cyclicals and Defensives

The U.S. stock market’s recent pullback has caught the attention of nervous traders and Wall Street macro analysts alike. While the retreat may seem like a typical correction, it is crucial to monitor the relationship between cyclical and defensive stocks to gauge whether bears are gaining control.

According to Jeff deGraaf, the Chairman and Head of Technical Research at Renaissance Macro Research, the S&P 500 index (SPX) has recently hit a new 65-day low, indicating a deterioration in this year’s market uptrend. As a result, there is a high possibility that the large-cap benchmark’s 200-day moving average (DMA), which currently sits approximately 3% below its current level, will be tested.

DeGraaf asserts that if the market is indeed heading towards a bearish trend change, one early indication would be a breakdown in the performance of cyclicals versus defensives. Cyclicals, which are stocks most sensitive to the economic cycle, are already feeling the impact of rising Treasury yields. The rate on the 10-year note recently surpassed 4.5%, reaching a 16-year high.

This surge in yields is expected to pose challenges for cyclical stocks in comparison to defensive stocks. DeGraaf highlights the implications of this shift (refer to chart below).

It is essential for investors to keep a close eye on these developments, as they could signal a more significant market correction and potential bearish trend change.

Recent market trends indicate some tactical weakness in the cyclical versus defensive trade, but the overall bullish trend remains intact, according to renowned expert deGraaf.

Stay Cautious on Defensive Stocks

While closely monitoring for any breaks in the current trend, it is advised not to excessively allocate assets to defensive stocks. The charts suggest that these stocks are mostly showing signs of being overbought and weak. The recommended approach is to minimize potential losses rather than expecting significant gains relative to the broader market.

Midcap Staples Show Promise

However, among defensive stocks, midcap staples appear to have exhibited quiet strength. Notably, they have recently reached new highs within a basing pattern. This makes them an attractive option for investment, according to deGraaf.

Recent Market Performance

On Tuesday, U.S. stocks experienced a significant decline, with the S&P 500 losing 1.1% and hovering around the 4,290 mark. Technicians often consider the index’s 200-day moving average as a reliable indicator of its long-term trend, which currently stands at 4,194.68. As of Monday, the S&P 500 had retreated by 5.5% from its 52-week high recorded on July 31. Nonetheless, the index still reflects a year-to-date increase of approximately 13%.

The Dow Jones Industrial Average (DJIA) also saw a decline on Tuesday, dropping by 290 points or 0.8%.

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