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"Actions speak louder than words."

Everybody (strategists, Twitterers, your neighbor) has an opinion, but what really matters is what investors do with their cold hard cash. Are buyers worrying recession will cause another leg down in stocks? Or are they optimistic bad news is already priced into baskets like technology? Since the stocks that perform best in those scenarios are different, tracking the performance of the major market, sector, and industry ETFs can give you an edge.

What's working now

The last major market low occurred on June 17. Since then, we've seen outperformance from defensive, recessionary-stage baskets, including healthcare, consumer goods, and utilities.

The embrace of recessionary-stage stocks makes sense given there's growing evidence the economy is slowing. In the first quarter, gross domestic product declined 1.6% and the latest Atlanta Fed GDPNow forecast for the second quarter targets a decline of 1.5%. Employment remains strong, however, initial jobless claims have been trending up since April, and the average hours worked per week has been declining all year. In June, the average workweek was 1% lower than it was one year ago.

Meanwhile, cyclicals are underperforming, including energy and basic materials. That makes sense too, because they do best in the late stage of the business cycle when inflation is rising. Lately, evidence suggests inflation is peaking, potentially creating a headwind for those stocks.

Overall, defensive sector strength and late-cycle weakness aren't shocking. What may surprise you, though, is that the tech-heavy NASDAQ 100 ETF and SPDR Select Technology ETF  (XLK)  are among the best performers since last month's low. 

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The jury is out on if this is merely a bear market bounce fueled by short covering or a more sustainable move up. Nonetheless, the performance suggests at least some investors are tip-toeing toward early cycle stocks.

Green shoots in technology?

In "Sentiment Will Shift Rapidly if We Rally in the Next Weeks," Top Stocks Helene Meisler highlights the shifting sentiment and the NASDAQ's green shoots, 

She writes, "I don't think sentiment is bullish but it is not nearly as extremely bearish as it was. I think we have seen many dip a toe back in. I also think if we can rally some more in the coming weeks (that is my view) we will see sentiment shift rapidly.

Lets begin with why I think sentiment has shifted. Technology. When tech/growth stocks are not collapsing daily folks feel better about stocks. And tech/growth has been improving for two months now. And improvement in tech is directly related to interest rates which peaked (for now) in that June period.

The June CPI and PPI data show headline inflation of 9.1% and 11.3%, respectively. That's significantly higher than wage growth, so the pressure on consumer budgets remains. Nevertheless, core CPI and PPI (inflation minus the volatile energy and food inputs) have declined each month since June, and that may be enough of a trend to embolden some to assume the Fed will become friendlier next year.

It's not just price action that's signaling creeping optimism. Meisler tracks the up and down volume on major indexes, and she's seeing improvement there too. 

She writes, 

"In July net volume for Nasdaq (up minus down) has been negative exactly two days? And one of those days it was negative by such a small margin that it could have easily been positive on the day. Contrast that with the NYSE, where so many of those energy names live, and we discover that there have been exactly three days with positive volume in July."

Up volume relative to total volume on the index has also been improving: 

The Volume Indicator I use is a 30-day moving average of up volume as a percentage of total volume. When it gets to the upper 30s/low 40s it's oversold (yes even in bear markets). That's because it takes a lot of selling to get a 30-day moving average down that far. How much selling has there been on the NYSE? Well this indicator got down to 42% last week (it now sits at a still oversold 43%). Compare that to the same indicator for Nasdaq, which bottomed at 42% in mid May and now sits at 53%. The Either/Or Market is alive and well."

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If technology's rally extends long enough, it could positively influence the highly-watched 50-day moving average on the NASDAQ. 

The 50-DMA has been declining since January but it could flatten out soon because the NASDAQ has been trading (essentially) sideways since early May. For perspective, the QQQ is trading at about the same price level as it was on May 10. If the NASDAQ recovers the 50-DMA (it's attempting to do that today), and it remains above it from here, then it would simply be a matter of time (and math) before it starts heading higher again. Historically, buying pullbacks to a rising moving average is more successful than buying pullbacks to a declining moving average.

The Smart Play

The NASDAQ's strength could capture more attention if it continues higher over the next week or two. However, we're likely to face yet another round of selling if the NASDAQ and SPDR Technology ETF fail to recover their 50-DMA.

Therefore, concentrate on the established trends in recessionary groups, such as healthcare, and keep a watchful eye open to see what happens in tech stocks. For perspective, in my sector model, which incorporates long and short-term momentum alongside fundamental data, such as earnings, defensive groups still rank better than technology, despite technology improving to "neutral" recently.

Overall, I suspect we're not yet out of the "choppy" market Helene has discussed previously. Summer is notorious for low volume, and that can make determining how 'durable' a move is challenging. Low volume increases volatility, and that's an important consideration given keyword reading algorithmic trading machines don't go on vacation like we do. 

Nevertheless, business cycle stages don't flip on or off like a light on a switch. Early adopters warm up to stocks in each cycle beforehand, which is why stocks are a leading indicator. Historically, stocks bottom before a recession ends, and they perform best in the year following earnings nadir. Therefore, you'll want to track how technology performs from here so that you know when to switch gears.

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