Leaders, Laggards, and Bounces

Markets continued higher this week and the SP500 is now positive year-to-date. The rally continues to impress and is meeting zero resistance. Movements do remain volatile and the weekly trend remains lower. A notable gap was filled this week from the open of the year. January started with a plunge, leading to a 10% drop in 3 weeks. We've now recovered that move. 

In the spirit of the March Madness basketball tournament, an analogy for this market recovery is similar to a team falling behind and having to try to catch up. They play lockdown defense, full-court press, and exert tremendous energy to close the deficit. If you have ever seen a team make a big comeback run, it is clear it takes a toll on them physically. The market is no different. After a run like this often a period of rest is needed. Don't be surprised if the torrid pace slows and even takes a step or two back. 

SPX Weekly Gap Fill

Often when a major gap is filled a process of consolidation occurs. A very positive development would be to see the market digest this strong recovery and gap fill, then resume higher back above the gap zone. 

As we have discussed before gaps tend to be areas of interest and provide strong support or resistance. After the run we have had to fill this gap expect a breather in the near future to regroup. 

How the digestion plays out will be important to watch as well. The most constructive scenario would be to see several weeks of tight consolidation. If you recall the last consolidation in Nov/Dec was very volatile and sloppy. It proved unstable and then broke down, leading to the January swoon. To avoid a repeat of this pattern we will want to see a tighter range develop and allow the market to rest without large scale selling taking place. 

When we assess market strength it's important to be aware of what groups are leading the rally higher and their relative posture compared to other sectors. Typically in strong market environments participants seek risky assets that will grow quickly as economic conditions improve. In weak environments participants seek out safer assets that won't be as sensitive to economic changes, those that pay dividends and sell products people generally need regardless; products like tobacco, toilet paper, and electricity for their homes. 

This week we are going to review the strength and weakness present in the market and draw our conclusions as to whether this market is healthy or not.

Leaders

 XLU- Utilities

Utilities remain one of the only two major SPDR Sector ETF's to be regularly making new 52-week highs.

Short-term this group is extended along with the market but there is little doubt of the strength present. 

XLP- Consumer Staples

The other SDPR Sector to be at new highs. This group is composed of those very products people need rather than want. Companies like Phillip Morris, Procter and Gamble, and Coca Cola. When these stocks are leading the market it shows risk aversion rather than confidence. 

The long-term chart of XLP shows not only 52-weeks highs, but all-time highs. 

REITS

Real Estate Investment Trusts tend to be high dividend paying investments. Participants seeks these when they foresee lower interest rates and are in need of income generating assets. 

While this group is not making new highs as a whole, the action looks very similar to the environment in early 2014. 

XLI-Industrials

One very encouraging sign is the emergence of the Industrial group. These tend to be more cyclical companies that outperform when economic conditions are strong. To see them as one of the better positioned groups is a positive so long as it continues. 

The weekly chart has also improved as the XLI is now trading above its Nov/Dec highs. The 20 WMA is now sloping higher and we want to see that area hold as support on the next pullback.

Laggards

IBB- Biotech

Biotech, the clear leader of the entire bull market, currently cannot catch a bid. If the market were truly strong and participants were seeking risk, Biotech would be amongst the leading groups. The fact that it barely bounced on this recent market surge is notable and this space should be avoided until it can prove buyers are willing to step in. 

When people mention a "canary in the coal mine", Biotech seems to be sending a message. Despite the broad market strength, true "risk on" behavior is not present at this moment. 

XLV

Spinning off of Biotech, the entire Healthcare Sector remains quite weak. There remains a clear trend of lower lows and lower highs. While a group like Industrials just took out its prior swing high, XLV is currently > 10% below its prior swing. 

The longer-term view confirms this weakness as the group was rejected this week off a test of its declining 20 WMA. 

XLF- Financials 

There is a saying "as the banks go, so goes the market". Well banks remain relatively weak and also are more than 10% below the prior swing highs. 

While the Financials have bounced back with the recent rally, they are still trapped below major supply levels. Some of the most promising Short setups I'm watching are in this group. C, BAC, GS, are my favorites and are getting close to key resistance levels.

Bounces

No question the most exciting groups in the market right now are Energy and Materials. The questions everyone wants to know are have they bottomed? Will the rally continue? These questions cannot be answered absolutely. We have seen some pretty interesting volume activity recently that tend to resemble major bottoms. But in reality these are still just bounces off of multi-year lows...Bear market lows. There is nothing in the trends that suggest these moves are over. It will be necessary to see how the pending pullback plays out to determine how much or little damage has been repaired.

XLE

The Energy group has rallied sharply during this recovery, trading some 30% off its recent low. However as you can see they are nowhere near their Nov/Dec swing highs. There remains a lot of work to be done before we can call an end to this bear.

The Weekly chart continues to show a dim picture. This trend is firmly lower and it seems most have forgotten this. 6-weeks ago everyone was convinced Energy was headed down the tubes. Companies would be going bankrupt, Oil gluts would never be relieved, etc. Fast forward to today and now everyone is convinced the lows are in and the Energy Bull is on.

I just want to be sure we are checking our sentiment and not getting carried away. On January 21st I made this post why I was bullish on Crude Oil. It happened to be a good call, but in reviewing my process I am in agreement that this is most likely a short-term relief rather than the start of a new bull market. My thesis that Oil remains in a "lower for longer" environment is not deterred by the fact that Crude just rallied 50% in the last 6-weeks. And it shouldn't be influencing you either. We tend to be emotional beings with very short-sighted bias, getting bearish at the low end of a range and bullish at the high end. There is nothing wrong with changing your opinion when facts change, in fact its necessary for our survival in the markets. But there is an important distinction between changing your mind to a real change in the trend compared to simply reacting to an oversold rally in a lagging sector.

Hey maybe Oil and Energy has truly bottomed, that would be great. But if it has bottomed and a new bull market is beginning, you don't have to be the first one in or lunge at current prices. There will be plenty of chances to participate should the trend continue and we see a longer-term higher low and higher high establish itself.

XLB

XLB is arguably in a much better position than Energy and the other lagging sectors. The recent strength has brought it back to the Nov/Dec highs. A breakout above that level would obviously be a positive. The move has been steep in the last several weeks so some rest would be beneficial to sustaining a viable breakout.

The weekly chart still shows a bounce off a multi-year low. We will want to see the next pullback hold a higher low and then resume above the previous swing high. This seems to be on decent footing and could be a sector to watch in the near future.


Bottom Line: The current sector movement and money rotation continues to favor defensive, risk adverse behavior. It appears conditions are improving but there is still work to do. The recent rally has been sharp and relentless, but until we see how a pullback is handled we won't know exactly what to make of the next likely move. Continue to ride short-term momentum and always take the signals your strategy offers. However this remains a market to be skeptical of until more offensive groups take the lead and we see some sustainable higher lows.

Thanks for reading
-ZT