The greatest thing since sliced breadth

S&P 500 and Nasdaq 100 futures are rallying as traders await the September non-farm payrolls report. Economists are looking for job growth of 90,000 with the unemployment rate holding steady at 4.1%.

Major indexes gained on Thursday, with the US benchmark index’s advance-decline line going positive for the first time this week. Photonics stocks went on a tear — a move that was sold by Robinhood traders. Coherent and Fabrinet in particular were dumped on heavy volume.

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Sliced Breadth

We appear to be in the “something’s gotta give” phase of the index/breadth divergence.

Barring a massive rally today, the S&P 500 Equal Weight Index will finish with its seventh straight week in the red for only the third time. The other two such periods ended in July 2002 and May 2022. Four and and 24 years ago, the cap-weighted S&P 500 was down double digits during that downdraft.

Right now? It’s down just 1.5% over the past seven weeks.

The resilience of tech heavyweights has kept the VIX Index below the voting age for the entirety of the equal weight index’s slump. During those other two episodes, the VIX peaked in the 30s.

The defining feature of the macroeconomic backdrop in the third quarter — and particularly the past two weeks — has been sharply rising long-term interest rates. This cycle, US stocks have tended to perform quite poorly when that’s happening!

To be fair, on Thursday, something may have been starting to give:

Stocks turned small losses into tidy gains after Fed Vice Chair Philip Jefferson said the central bank may need “more time” before any more rate adjustments, which caused traders to aggressively curb bets on a hike this month.

Long-term Treasury yields fell as well. And although small caps and the Russell 2000 couldn’t best semis on the session, they did at least outperform the S&P 500 and Nasdaq 100.

“The new quarter brought a small up day, and breadth was actually positive although not hugely so,” wrote technical strategist Tom McClellan. “Still, it was a dramatic change from the long string of negative breadth days.”

Short-term breadth has gotten “about as low as it has been able to get the past 4 years. It is still possible for it to go lower,” he added. “Oversold can always get more oversold. But this is pretty stretched. And these low readings are associated with important price lows. The key point, though, is to remember that “associated with” is not necessarily the same thing as ‘at’.”

Maybe a catalyst could come from this morning’s payrolls report, or maybe it’s something that will take a little longer. By the middle of the month, we’ll have started another earnings season with the banks, September CPI as well as retail sales, and a steady chorus of Fedspeak.

Color me surprised if we’re still talking about a big breadth-index decoupling at the end of that.

Choose your narrative, good or bad. We’ve already seen a hot payrolls report and rising rates speed check the AI momentum trade once this year (in early June following the May jobs numbers). Or maybe continued signs of economic strength — the kind that put upward pressure on rates — are also considered a testament to solid activity ex-AI; a reason to buy the laggards.

With how well the heavyweights have performed amid rising rates, any sustained stability in the long end or retracement in yields could spark similar reversals in the stock market.

“If yields do fall, it's likely to see a reversion of the Invesco QQQ Trust vs. iShares Russell 2000 ETF ratio and all the similar correlations,” wrote BTIG chief market technician Jonathan Krinsky, arguing that “In other words, while that could see breadth rebound from extremely oversold conditions, lower rates could also see QQQ and Mag7 actually move LOWER.”

“Call options on rate-sensitive equities, including Real Estate, Utilities, Russell 2000 and Homebuilders, offer attractive exposure to a rate-relief scenario,” wrote Goldman Sachs analysts led by Christian Mueller-Glissmann earlier this week.

(You know who could definitely use some rate relief? The retail traders who swarmed into the iShares 20+ Year Treasury Bond ETF in September, per JPMorgan’s Arun Jain.)

Or perhaps AI retrenches for its own AI-y reason (model hacks that do real damage, a perceived harsher regulatory environment after the midterms getting priced in, Dario or Sam opening their mouths, etc).

In any event, when conditions get so stretched, markets can move less on “reasons” and more on “excuses.”

Trends (and narratives) change pretty fast. Just look at banks, another pocket of the market under acute stress as of late. These headlines are less than two months apart:

The KBW Bank Index closed 13% below its 52-week high on Thursday, compared to an S&P 500 that’s less than 2% from its all time peak.

This type of performance gap is actually much more common than the aforementioned cap-weighted vs equal weight disparity. And it’s also one sign pointing to a potentially happy resolution to this divorce between internals and the index.

Three-month forward returns have tended to be well above average for both the S&P 500 and banks whenever the benchmark US stock is this close to a 52-week high and the banking industry isn’t.

Notes: The unconditional returns for the S&P 500 and banks over this period — from 1992 to the present — are 2.43% and 2.39%, respectively. For this analysis, we used only the first instance in a 13-week stretch to avoid overlapping/double-counting.

Just DooDoo

One name that is not helping to facilitate any rebalancing to consumer or rate-sensitive stocks is Nike.

Shares swooshed lower after Q1 revenues came in shy of estimates and management said sales would suffer a high single-digit decline this year, while the Street was pencilling in a drop of 2.4%

(via X)

At this point, the athletic apparel company should probably change its name to Oizys. (A bit niche, Google it.)

But enough about Nike and more talk about the type of company Nike is: one that is likely vulnerable to tax loss selling.

“Institutional clients have typically been big net sellers of stocks in Oct., when tax loss selling occurs by mutual funds with 10/31 year-ends vs. in Nov./Dec. for retail investors,” wrote BofA strategists led by Jill Carey Hall. “We have been fielding requests for a screen of tax loss candidates earlier in recent years, but flows this month were not suggestive of a shift earlier in tax loss selling: sales of single stocks by institutional clients were smaller than in the typical Sept and well below the typical Oct, suggesting flows may still turn more negative next month.” [i.e., now!]

Nike is one of less than two dozen S&P 500 companies within 5% of its 52 week low while having declined in every quarter this year:

(There are certainly a number of other ways to gauge potential tax loss selling candidates; this is just one starting point.)

In September, Hall’s colleague Savita Subramanian observed that Microsoft, Apple, and Amazon, as well as companies that had been losers year to date, were sold by funds that added SpaceX after its IPO.

With Anthropic reportedly targeting a pre-Thanksgiving IPO, that could potentially accentuate divestments of 2026’s losers or stocks thought to be closely linked to the Claude developer.

Whispers from Wall Street

Via JPMorgan equity derivatives strategists led by Yangyang Hou:

“If local implied volatility is low, skew and convexity is usually very elevated to compensate for tail risks, especially with the dislocation from fixed income markets. However, even this is not the case for US equity index. We think one of the drivers is the single stock skew.
The upside inverted single stock skew could be attributed to call replacement strategies by investors locking in the hefty ytd gains or increasing exposure in a conservative way. Currently, almost 40% of the liquid names have Upside inverted skew (Figure 7). The downside skew, on the other hand, is getting very flat (Figure 8), partially due to the already elevated ATM vols.
As a result, index volatility has a floor on the upside, otherwise the implied correlation would be too low to make sense. Subsequently we see a spot up vol up effect, which is likely to continue especially if single stock skew continues to be inverted on the upside.”