ChartWatchers Newsletter

Midcaps May Show Truer Picture of US Stocks

Several of my recent messages have focused on the divergence between large and small cap stocks. Wednesday's message suggested that part of that divergence was due to stronger foreign markets. Large cap multinationals do better when foreign markets are strong, which is the case at the moment. Small stocks are more closely tied to the U.S. economy. So which one is giving us the right story? Midcap stocks may be giving us the truest story of the state of the U.S. market. That's because they're right in between the two other extremes. So far this year, midcaps have gained 4% which is half as much as the S&P 500 gain of 8%. But it's still twice as much as the 2% gain in the Russell 2000 Small Cap Index (and 4% better than the S&P 600 Small Cap Index). And the midcap chart looks positive. The chart below shows the S&P 400 Mid Cap Index (MID) in a sideways consolidation pattern since its early March peak. In addition, the two converging trendlines look like a bullish "symmetrical triangle" formation. That increases the technical odds for an eventual upside breakout. That would broaden out the market uptrend which has been led mainly by large cap stocks. [Small caps are leading today's market bounce with the Russell 2000 regaining its 50-day average. That's encouraging if it continues].

Are You Watching Energy Stocks?

Energy stocks have been declining since December for the most part. This would be one of the best clues that the investors do not like the trends inside the industry. Now the Bullish Percent Index for Energy is under 20%. Here is the good news. The sector can stay down here for a while, but eventually, these stocks will come to life. As a matter of fact, there is a nice rhythm in the momentum for energy stocks. Let me put a few charts up to whet your appetite for a little black wine sometime later this year.

First of all, here is the Bullish Percent Index for Energy ($BPENER). We can see the Index is near the lowest levels of the last few years. The level around 15% to 20% is usually where meaningful bottoms are built. We can also see the momentum shown by the MACD is very low. The MACD is also flattening out here. So, the first clue for us is that the downside momentum is waning somewhat but that does not mean the bottom is in for energy stocks. You can see that looking at the Exploration and Production ETF (XOP) as well as the Energy Sector ETF (XLE).

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The Most Important Assumption in Trading

Trading and investing are all about putting the odds in your favor, and chartists can increase their odds with one key assumption: the trend will remain in force until proven otherwise. Coming from the writings of Charles Dow, this assumption means a trend in motion is expected to stay in motion. In other words, assume that the trend will extend, not end. Using a top-down approach, you can incrementally increase your odds of success by starting with the broad market trend, and then extending your trend analysis to the sector, the industry group and the stock. This article will show an example using two classic moving averages to determine the big trend. 

The S&P 500 SPDR (SPY) represents the broader market and we can use the classic 50-day and 200-day moving averages to identify the primary trend. Personally, I prefer exponential moving averages because they put more weight on recent data. In addition, chartists can use the Percentage Price Oscillator (PPO) to measure the difference between two EMAs. The chart below shows the S&P 500 SPDR (SPY) with the PPO(50,200,1) in the indicator window. The red lines show when the PPO turns negative and the green lines show when it turns positive. There were just ten crosses over the last ten years and some whipsaws, but the trends outweighed the whipsaws. The uptrend that started in 2012 lasted over three years and the current uptrend is over a year old. 

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S&P 500 and SPY Trigger New Weekly PMO BUY Signals

The S&P 500 garnered a new PMO BUY signal on the weekly chart. Now we have two Scoreboards that are completely green. Technology has been a darling for quite some time so it is no surprise to see the oldest BUY signals residing on its Scoreboard. The two SELL signals remaining on the Scoreboards are on the Dow and OEX. The weekly charts for all four Scoreboards are below.

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Foreign Markets Retest The Highs

With the big swing this week, some of the foreign markets are retesting breakouts. Below are just a few markets to watch in the next few weeks.

Australia ($AORD) failed to hold the breakout to new highs and has now lost the 10 WMA. While losing the 10 WMA is not that big of a deal, the size of the downward stroke right after trying to break through previous highs suggests not a lot of support for the breakout. The 40 WMA is just below and the first test of the Moving Average is usually a bounce. The lower channel is around 5400 with the 40 WMA about halfway in the channel.

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Rising European Currencies Are Pushing the Dollar Lower

While stocks were rebounding last week, the dollar wasn't. Chart 1 shows the Power Shares Dollar Index ETF (UUP) falling again Friday to the lowest level since November. It may seem surprising to see the dollar continuing to drop with bond yields bouncing along with stocks. The dollar drop, however, may have more to do with improving European currencies. Chart 2 shows the Euro surging to the highest level since last October. Improving economic conditions in the eurozone (as reflected in strong stock prices), as well as an uptick in inflation, are supporting that currency. The Euro has the biggest weight in the Dollar Index (57%). As a result, its rise is the biggest reason the UUP is falling. Chart 3 shows the British Pound climbing to an eight month high as well. That's a sign of more optimism in the UK economy. All of which suggests that the drop in the dollar may have less to do with deteriorating conditions in the US, and more to do with an improving situation in Europe. That also explains why global funds have been rotating into Europe. American investors are getting dual benefits from rising European stocks as well as currencies. That's giving a added boost to European stock ETFs that are quoted in weaker dollars. The falling dollar, however, is finally giving a lift to commodities.

Broad REIT ETFs Hit Interesting Junctures, but Hotel and Retail REITs Weigh

The REIT iShares (IYR) and the Vanguard REIT ETF (VNQ) are at interesting junctures because they corrected within an uptrend. Even though both are at potential reversal zones, chartists should be careful because retail REITs and hotel REITs are weak spots within the REIT universe. The chart below shows IYR with an uptrend since November and a recent pullback to the rising 200-day EMA in May. The ETF held just above this EMA and firmed the last two weeks. It got a bounce on Thursday-Friday and a breakout at 79 would reverse the April-May pullback.

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Bearish Signals Continue to Mount

It was a rough finish to the week and it has shaken up the DecisionPoint Scoreboards. Additionally, the Intermediate-Term Trend Model (ITTM) generated a Neutral signal on the equal-weight Financials ETF (RYF) and a weekly Price Momentum Oscillator (PMO) SELL signal popped on the equal-weight Consumer Discretionary ETF (RCD). Believe it or not, these Scoreboards were completely green on May 11th (except the Dow IT PMO SELL). We began seeing signs of deterioration even before this week's short-term correction when the IT PMO signals on the SPX and OEX triggered a SELL signal on 5/12. 

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When in Doubt, Sit it Out

Anyone who trades the market on a regular basis knows how important it is to use whatever tools are available to make important decisions. This includes using charts to determine the strength/weakness of a specific stock, sector or index, zeroing in on key price and technical support/resistance levels and getting a handle on the overall mood of the market. For me one of the key indicators I use to help me make decisions is the VIX, what many know as the market fear meter.

To give you some historical perspective, the all time low on the VIX was near 9.40 in December, 2006, while the all time high was near 90. Last week got as low as 9.56; pretty darn close to the all time low. Traders look at the VIX in one of a few ways. First, when it is extremely low it signals traders are relaxed and in a buying mood. If it's too high then there is a lot of worry and traders get more defensive. However, I have often used the VIX as a contrarian indicator; if it gets too low it shows too much complacency - time to buy - and if it gets too high traders might be too scared - time to sell.

For example, just look at the chart below on the VIX from last week when it neared its all time low. It spiked dramatically as the market sold off sharply on Wednesday. That made sense to me as in looking at the VIX I felt the market had gotten way too complacent; a pullback was overdue, and we got one. I was feeling pretty good having shifted my trading bias to the downside. Now fast forward two days to Friday and lo and behold; the market moved from being scared to being more relaxed. My short bias was short lived!

When I start seeing big swings in the VIX like we have the past few months the first thing I do is get more defensive as everyone is getting whipsawed, both on the long and short side. This makes it more difficult to come out on top either on the long or short side and can often be painful in the pocket book. The other thing we do at EarningsBeats is scan for companies that look very oversold and have reported strong earnings. These are added to our "Candidate Tracker" and some of these become trade alerts for members. If you would like to see a sample of the Candidate Tracker just click here.

The bottom line to me is this; when volatility picks up like it did last week it makes sense to get more defensive. This can include being much more selective, trimming position size, tightening stops and locking in profits whenever possible. And, for those who flat out want to protect capital at all costs, simply moving to the sidelines until things settle down.

At your service,

John Hopkins

Are We Topping? Watch These Two Industry Groups

We saw the first significant selling pressure in months last week, especially on Wednesday.  Financials (XLF) led the rout to the downside, but the sector did bounce back later in the week and, in the process, held key neckline price support within two key industry groups - banks ($DJUSBK) and life insurance companies ($DJUSIL).  Both of these groups do well in a rising interest rate environment so it'll be important to watch the 10 year treasury yield ($TNX) as well to see if the TNX can hold onto key yield support levels.  Here are the DJUSBK, DJUSIL and TNX, all featured on one chart:

The TNX has been successful in defending yield support in the 2.15%-2.20% range.  Should that continue to hold and start to rise again, then look for both the DJUSBK and DJUSIL to hold the green support lines above and lead the next rally.  A continuing drop in the TNX, however, would likely result in breakdowns in both banks and life insurance companies and that most likely would also signal overall stock market weakness into the summer months.

Happy trading!