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Consolidation likely this week after Sector ETFs hit resistance

July 18, 2016

S&P SEPT FUTURES (SPU6)
Contact: info@newtonadvisor.com

2139-43, 2119-20, 2096, 2075-7    Support
2164-8, 2175-6, 2183-5                  Resistance

 

Bloomberg World index along with many other Sector ETFs have NOT broken out like the SPX did, but remain near former highs, which could allow for some consolidation to unfold.

 

Key Takeaways

Worst over for Financials?  A good bounce, but more work needs to be done
The surge in yields over the last two weeks has proven to be a good catalyst for a meaningful bounce in Financials.  This group remains this year's Worst performing sector, the only S&P sector down on the year, with -1.46% returns, through 7/15/16.  Yet, last week returned the 2nd best performance of any of the S&P GICS Level 1 groups, higher by 2.57%, second only to Materials.   This was a important positive for the broader market given that Financials represent over 15% of the SPX, the second largest group by capitalization.  Much depends on further signs of improvement in US growth for this group to work, as this directly impacts the trajectory of interest rates. 

Bottom line,  it still looks early for intermediate-term outperformance in Financials, but a good start-  We've seen a minor bounce in the group after holding right near key trendline support that has held the group in relative terms right near where it bottomed in the past vs SPX.  (So it held and bounced right where it needed to)  On an absolute basis though, Financials looks to have stalled in the last trading day right near key trendline resistance on the bounce.    Two Key Takeaways:  First- Financials should be starting a larger bounce into August/September, relatively speaking, and the last couple weeks were encouraging.  Second, on an absolute basis,   the area at 23.80-24 is an important area of resistance that lines up with former highs from last year.  Until this area is exceeded this initial bounce could "Back and Fill", pulling back to 22.75-23.15 over the next 3-5 days before pushing higher.  The ability to exceed $24 would be the first instance of this long-term trend being surpassed since last Summer, and will have successfully gotten over an area that held on two prior rally attempts, one in late 2015 and another into late May, both which failed.  A breakout now has NOT yet happened, but WOULD likely happen if yields can continue their upward ascent on higher US Economic growth, and is something to be watched for carefully in the weeks ahead.

In terms of the broader market, the SPX and DJIA managed to climb to new all-time highs, yet many of the other indices such as DJ Transports, Russell 2000, and NASDAQ Composite remain well off their peaks.  The S&P Mid-cap and S&P Small cap indices have also risen to challenge former highs, but have NOT YET broken out, while the Bloomberg world index is now right back near April lows, also potentially a temporary hurdle.  Overall, the SPX breakout is important, but also important that other indices follow suit and begin to take out monthly highs and show strength as well.  For now, the LACK of other indices showing similar breakouts does not mean that the US Rally can't be trusted, as these moves take time for other indices to line up in unison.  But it is a worry that Europe is still lower by 20%, the DJ TRANSPORTS and Russell are down 10-15% from highs.  Eventually either these will need to move up sharply , or the S&P could fade and pullback, negating this breakout as being false.

Technically it's unlikely that the SPX suffers any more than a short-term pullback to consolidate overbought conditions.  The degree of bearishness towards stocks a month ago coupled with Advance/Decline lines hitting new all-time highs with impressive sector rotation were good signs that a more meaningful rally could happen, and that this giant one-year + Trading range could be resolved by an upside breakout rather than failure.  While sentiment has started to move quickly from bearish to near bullish territory, and breadth has begun to back off in the last week while prices have edged higher, the structural improvement in DJIA and SPX are meaningful and should provide for additional gains into the Fall.  Sectors like Healthcare and Discretionary and now Financials are starting to perform, so this also is a bullish factor that supports this move on a 1-2 month basis.

At present though, prices seem to have moved a bit too far too quickly and the 9% move in 12 trading days will need to be consolidated.  Sector ETFs like XLI, XLY, XLK, XLE, XLB, have all moved to former highs and/or areas of trendline resistance that will make further gains difficult to come by.  So despite the SPX having broken out, many of the underlying ETFs have not, and are up against key areas.  Near-term overbought conditions coupled with former highs in resistance and a bearish seasonal tendency for late July could all weigh on the market in the coming 3-5 days.  However, pullbacks should be used to buy dips and position for a move up above 2180 to near 2250 before any real pre-Fall peak.


Short-term Thoughts (3-5 days) : Bearish- As mentioned above the fact that many of the constituent ETFs are up near former highs while near-term momentum remains overbought and breadth has eased in recent days.  Additionally, sentiment has grown more bullish, with DSI (Daily Sentiment index) readings in the high 80's.   There should be a selloff down to at least 2096 in S&P futures, potentially to 2074 over the next week before this rise can continue.  Though prices haven't confirmed a pullback is underway the surrounding evidence for a minor drawdown is becoming compelling.  Over the next week, use pullbacks to buy dips, but likely its best to hold off until at least 1/3 of this prior rally has been retraced.


Intermediate-term Thoughts (2-3 months): Bullish- Last Week's breakout to new high territory for SPX likely should soon be followed by other indices such as DJIA while NDX, CCMP should push up to test former all-time highs from last year.   While the ongoing lagging in Transports and Small caps is a concern, as these remain 10-15% from all-time highs and similarly, most of the world remains well off all-time highs, it's right to stick with US stocks until some evidence of counter-trend sells arise or breadth starts to falter meaningfully in a way that would lead to a top in stocks.  Both daily and weekly momentum as per MACD are positively sloped, while monthly is sloping upward and close to turning back positive for the first time since early 2015.  Bottom line, with Advance/Decline at new highs, it's difficult to fade the market, and the lagging sectors have all started to bounce in a way that should lead to some mean reversion in these sectors.  Key cycle dates for trend change lie in late August, and very well could lead to a peak in stocks, but for now, it's right to stick with this trend on an intermediate-term basis until ample signs of weakness arise.  The other concern is that given the degree of deterioration in momentum last year into those August lows, even this push to new highs won't allow momentum to get anywhere near where it was back in late 2014/early 2015 and this is a 12-18 month concern.  For now, for this time frame, additional intermediate-term strength still looks probable with key targets at 2180-5 and then 2250.

Absolute and Relative Charts of the Financial Sector, including sub-group relationships, Treasury yield charts

 

 

Financial Select Sector SPDR- (XLF- $23.52) Still too early to think a major move is underway in Financials, but the progress in the last couple weeks has been encouraging.  As this daily chart of XLF v SPX shows, Financials have been guided by an intermediate-term downtrend from last Summer which has marked no less than two major highs going back since the latter part of 2015.  The highs from both Nov/Dec 2015 as well as late May in 2016 were both repelled right at this area, and last week's rally was also halted there, at 23.80-$24.  While the near-term uptick in momentum has been impressive, the ETF is being held at this trendline and should limit the performance of Financials in the short run after a big move in the last couple weeks.  However, following consolidation, if prices manage to get back up and exceed $24, this would be a very strong signal that this group, along with the major US Market likely, should continue much higher into the fall.

 

FINL.gif

 

Financials relative to SPX-   Encouraging ability to hold where needed and Bounce, but more progress necessary-  As this relative chart shows, Financials managed to stabilize and bounce at an exact area of key trendline support which has held this sector in the last six months.  The ability to hold where it needed to and then turn back higher is a bullish development overall for Financials, but yet more work needs to be done before suggesting this group can start to trend higher meaningfully.  Similar to the SPX, some backing and filling looks necessary.  Of the top performing stocks in the last week: LM, LNC, MET, RF, FITB, STT, GS, hardly any of these look attractive heading into late July given their 5-8% gains last week as part of ongoing poor near-term technical patterns.   For now, most of these will be much better risk-rewards if the group can pullback a bit over the next week

 

 

The Citigroup Economic Surprise index managed to eclipse 0 for the first time since early 2015, showing a measurable uptick in economic data beating expectations right at a time when most had begun to hunker down post the BREXIT decision.  This goes a long ways toward confirming much of the initial thought that Yellen had expressed over a month ago that a Summer hike was feasible, until the BREXIT uncertainty reared its ugly head.  Now that this uncertainty has passed and US economic growth seems to be ticking higher, Fed Fund futures should once again start to price in a Rate hike for 2016.  Furthermore,  additional escalation in bond yields would go a long ways towards helping the Financial sector begin to perform much better.  Overall, keeping a close eye on how economic reports are influencing bond yields helps to add some insight regarding how the Financial sector can perform.

 

 

10-year Treasury yields managed to bounce hard in the last two weeks, and now lie just below an area of key resistance to the upside that should prove important in holding yields after this first major move higher.  Until 10-year yields can get above 1.70%, this rise in yields should be used to sell into, (meaning Buy Treasuries) in thinking that rates have bounced too quickly, similar to stocks in the last couple weeks.  After a pullback, the first meaningful area of upside resistance will be this downtrend line from late May.  For now though, bond bears have had life a bit too good in the last couple weeks and its likely that yields start to stall out after this initial surge.

 

 

Regional Banks starting to thrive.   The ratio of Regional banks vs the broader Banking sector (KRE vs KBE) has just begun to lift back to new highs after nearly four years of consolidation.  This ratio did bottom in 2013 but now is beginning to accelerate in parabolic form of late and has just moved back to new all-time highs.  This should bode well for continued outperformance by the Regionals in this environment within the Financial space.

 

 

SPDR S&P Banking ETF-  (KBE- $31.89)  Similar to XLF, the Banks have pushed higher as part of the downtrend from last year and also find themselves just under a key area of trendline resistance that should make further progress difficult in the short run.   The area at 32.80 should be important in causing resistance to this move that causes some slowdown in this push higher after a steller bounce from $28, just a couple weeks ago.  For now, it's right to be very selective in this space until this move has had time to consolidate.  The area above $32 up to $32.80 should be used initially to sell into gains in KBE, thinking this stalls out and backs off a bit after this recent rise.

 

 

 

Brokers have bounced vs Banks, and now reaching key resistance which means some of the gains in GS, MS and other Investment banks/brokers likely should stall out this week after the bounce.  The ratio chart above highlights the IAI (Broker Dealer ETF) vs the XLF, (the Financial Select SPDR ETF) .  The sharp rally from late June has reached an area that's been important from last November/December highs.  A stalling out is likely given that 10-year Yields have also reached key resistance.  Consolidation that takes place where this ratio could pullback and make a higher low before rallying back above this downtrend would make this far more attractive environment for the Broker dealer stocks.  For now, this rise looks like a selling opportunity short-term.

 

 

Insurance stocks look to be starting to peak out after a strong period of outperformance throughout 2015 vs the Financial space.  The peak in early 2016 was tested into last week, but looks to have failed which is causing a pullback in many of these names over the last few days.  While the uptrend from late 2014 remains intact this will need to be watched closely given the rapid move higher in yields in the last few weeks.

 

 

REITS managed to move back to new high territory in the last couple weeks, and the intermediate-term pattern in REITS continues to look very good as VNQ moved over both 2015 highs as well as exceeding highs from 2007.  While a meaningful uptick in rates would hurt this group and cause this to turn back lower and/or underperform, the technical structure remains quite attractive.  Given that yields have rallied up to near key resistance in the short run, any pullback should likely help REITS continue to show outperformance.   This last week saw underperformance in many of the REITS which have performed well all year, mostly yield related.

 

 

Financials vs Utilities, as shown in ratio form by XLF v XLU, has rallied back up to near key resistance per the downtrend line extending from late last year.  The act of getting back over prior lows that were breached represented the first positive, while getting back over this trendline would argue for a meaningful move higher in Financials vs the Utilities, where Financials would be overweighted and Utilities underweighted relatively speaking.  Overall, if yields continue to rally in the next few weeks/months, this should help the Financial sector continue to show good strength, while Utilities should have more meaningful underperformance.
 

 

 

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