2 Technical Setups Are Clashing — Where to Focus for Opportunities
The same news can be bearish for the indexes and bullish for the underlying market.
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Optimistic but uncertain progress on a deal with Iran is producing a positive but relatively mild market reaction on Tuesday morning. President Trump said on Memorial Day that talks with Iran to end the war were “proceeding nicely,” and earlier said Iran “gave us most of” a 15-point plan, with 20 boatloads of oil to start moving through the Strait of Hormuz as a sign of progress. However, there is still some defensive military action taking place, and Iran appears to have significant internal disagreements.
West Texas Intermediate crude dropped more than 5% in early trading on the comments. Treasury yields are easing Tuesday morning, with the 10-year backing off substantially. Futures are positive but not euphoric.
The muted response is due to two major themes hitting the market at the same time. The Iran resolution has been telegraphed for so long that a resolution has already been discounted to a great degree. The conditions for a sell-the-news reaction are in place, and investors know it. However, there is also very bullish action in the average stock.
Two Technical Setups Are Clashing
Conditions are good for both rotational action and some sell-the-news action. The Magnificent Seven and the cap-weighted indexes are extended, but the Invesco S&P 500 Equal Weight ETF (RSP) broke out on Friday, and the average stock is nowhere near as stretched as the media would make you believe. That divergence is where the best opportunities lie.
The mega-caps that ran into record closes on Friday have the most potential to sell into strength. However, a rotation has been building, so the money coming out of the mega-caps is likely to flow into secondary names.
A selloff in Nvidia (NVDA) and the Mag 7 with the RSP holding or extending is the theme to watch. The same news event can be bearish for the indexes and bullish for the underlying market.
A sell-the-news response may not hit yet as there is still uncertainty about an Iran deal, but once it is done, that event will be fully discounted. In the meanwhile a broad rally could be driven by FOMO.
A third possibility we need to watch for is an initial rally and then a reverse that takes everything down. I think this is unlikely, but it will depend on whether negative sentiment starts to build if the market can’t run on this news flow.
The Rate Caveat
Lower oil and easing interest rates are both driven by progress on Iran, but we need to stay aware of a divergence. The yield easing is a positive, but the structural backdrop is dangerous.
Even with oil prices lower, the FOMC minutes confirmed a hike bias, Fed Governor Waller delivered hawkish comments Friday, the global bond rout has not eased materially, and University of Michigan inflation expectations rose to 4.8% on a one-year basis and 3.9% on a five-year basis. The bond market is still pricing roughly a 40% probability of a hike by year end. Can lower oil prices fix all those problems?
Progress in Iran removes oil as an issue, but we still have tariffs, fiscal deficits, sticky services inflation, and other issues driving longer-term yields to multi-decade highs. Iran doesn’t necessarily fix this issue, and that is another reason to watch for some sell-the-news action. Interest rates will tell us a lot about where the market is heading.
The Conference Board consumer confidence reading at 10 a.m. will be more important than usual, even if it doesn’t reflect developments in Iran. A weak number that converges with the UofM record low will be a clear message that consumers are struggling, and the economy may have issues outside the AI frenzy.
Where to Focus
The biggest mistake a trader can make this week is to get distracted by the direction of the major indexes. The cap-weighted measures, like the S&P 500, will be moved around by positioning moves, Iran headlines, and interest-rate reactions.
Stay focused on themes, sectors, and individual stock picking. The themes that have been working are the rate-sensitive groups that catch a bid when yields ease, the new generation of AI leaders pulling capital from the existing mega-caps, and the smaller-cap names with their own catalysts that get re-rated as the mega-cap concentration unwinds.
Quantum computing is extended on Friday’s grant news. Biotechnology has been responding to rate relief. The AI energy suppliers have been embraced by momentum traders. Those are the groups to watch under the surface while the headlines do whatever they do.
Strategy
I’m sticking with my reactive approach to the market and will be aggressive if the themes I’ve outlined gain traction. My cash level stays high, and my incremental buys stay small, but I’m putting more cash to work if I find smaller names with solid fundamentals and their own catalysts.
Stay focused on the equal-weight RSP. If it outperforms while the cap-weighted indexes fade, it would be the strongest possible confirmation of the character shift.
Breadth running broader than the index move will be a tipoff. Small-caps outperforming the Nasdaq for another session will be another positive sign. Watch those, not the headline numbers.
At the time of publication, Rev Shark had no positions in any securities mentioned.
