Trading Places with Tom Bowley

Bull Market Resumption Awakens The Hibernating Industries; We're Going Higher Folks

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Market Recap for Tuesday, June 12, 2018

The Dow Jones lost one point yesterday, but our other key indices finished with gains, led higher by the NASDAQ (+0.57%) and small cap Russell 2000 (+0.46%).  It was another boring day of bullish action with perhaps one slight negative - utilities (XLU, +1.15%) led the climb.  I'm happy to ignore that defensive posturing as it really resulted mostly from an oversold bounce.  Utilities are not leading this bull market rally as the following chart illustrates:


Performance on an absolute basis has been dismal, as evidenced by the weak PPO, well beneath centerline support.  Also, the XLU:$SPX ratio was testing longer-term relative support so a bit of relative strength could be expected here.  But make no mistake about it, utilities are the weakest link in the sector universe and are likely to suffer further as I believe we're now in an environment of rising interest rates.  For many investors, utilities represent a play on high dividends.  Those dividends are not nearly as attractive as treasury yields rise.

Energy (XLE, -0.76%) was weak on Tuesday, but one of its component industry groups - renewable energy ($DWCREE, +3.57%) finally saw a bit of relief at key gap support.  You'd never know there'd been a downtrend in the group if you looked at Sunrun (RUN), but others in the industry have taken a massive beating in June:

Picking out a trade candidate for a possible rebound in the group is difficult and could vary depending on your own trading style.  Clearly, RUN is the best looking chart technically, but it's been straight up and is extremely overbought in the near-term.  My personal favorite would be SEDG as it's on my Strong Earnings ChartList, which is a list of stocks that have beaten Wall Street estimates as to both revenues and earnings with solid charts.  SEDG has been dragged lower by the overall industry group weakness and is now at a strong reward to risk entry level.  A close below 50 would spook me.

Home construction ($DJUSHB, +1.84%) led consumer discretionary (XLY, +0.48%) higher for the second time in the last three days and appears to be gaining traction.  Rallies in the group have failed near 840 the past two months and the DJUSHB closed yesterday at 839.87.  We'll soon find out if there's any additional strength left in the group.  This test of resistance comes at a very interesting time as we'll hear the latest from the Fed at 2pm EST.  Will 840 mark the top again?  Or will home construction regain strength despite the prospects for higher interest rates ahead?  Check it out:

I'm assuming we'll get another quarter point rate hike this afternoon and the Fed will speak of a strengthening economy that suggests further rate hikes ahead.  Home construction is obviously interest rate sensitive so it'll likely be one of the most watched groups as the day unfolds.  Here's the question to ponder.  Are traders in home construction stocks going to be more swayed by a positive economic outlook and send this group higher?  Or will they instead focus on the headwinds that higher interest rates can create?  If I had to guess, I'd expect a knee-jerk reaction lower, followed by a breakout to the upside.  While higher rates can be a hindrance in time, we need to realize that interest rates are near historic lows and rates moving up from this level should be a welcome sign of relief as our economy strengthens.

Pre-Market Action

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Treasury yields are flat as head into "Fed Day".  We'll find out in several hours what the Fed's plan is today and what they see as we move into the second half of 2018.  I'm expecting a quarter point hike, along with most everyone else.  Anything different would be a shock and Wall Street doesn't like shocks.

Gold is flat.  Crude oil is down slightly near $66 per barrel.  Asian markets were mixed overnight, although the Hang Seng Index ($HSI) was hit relatively hard, dropping nearly 400 points, or 1.22%.  European markets are fractionally higher this morning and Wall Street appears to be taking its cue from Europe.  

Dow Jones futures are higher by 33 points with roughly 35 minutes left to the opening bell.

Current Outlook

Transportation stocks ($TRAN) have been quietly regaining serious upside momentum and they recently pushed to a fresh all-time high vs. utilities ($TRAN:$UTIL).  There is no way to view this but bullishly.  Here's the latest surge in transports relative to the defensive-oriented utilities:

Transportation stocks do well when the economy is strengthening.  Utilities do not.  The stock market prices securities based on a forward-looking approach.  So when I see the TRAN:UTIL ratio break to an all-time high, I grow very confident about the sustainability of the current bull market advance.

We're going higher.

Sector/Industry Watch

The Dow Jones U.S. Biotechnology Index ($DJUSBT) closed at its highest level in nearly three months on Tuesday, setting the stage for a potentially significant rally this summer, the group's favorite time of the year.  The May through August time frame has produced an average of 8% returns over the last 20 years and July is, by far, the industry's best calendar month.  More on that below in the Historical Tendencies section.  Let's take a look at the technical picture:

The current picture looks quite similar to the setup in December as the DJUSBT strengthened back then to fill a gap created in October.  The PPO was strengthening and crossed its centerline, just prior to exploding higher by 10% in a 3-4 week period in January.  Biotechnology stocks tend to move very quickly in both directions and this volatility does make investing in the group riskier for sure, but at the same time potentially more rewarding.  I expect the DJUSBT to continue to fill the bottom of its gap at 2031 initially, then the top of its gap closer to 2075 as well.  We've already seen a "golden cross", where the shorter-term 20 day EMA has crossed above the 50 day SMA.  That's a positive signal that also occurred in December, just before that January rise.

Historical Tendencies

This is worth repeating.  Biotechs love the summer months, especially July.  Over the past two decades, the DJUSBT has risen 75% of Julys and has averaged gaining 4.5% during this one month alone.  The fact that the group is acting much better technically adds fuel to the fire.

Key Earnings Reports

None

Key Economic Reports

May PPI released at 8:30am EST:  +0.5% (actual) vs. +0.3% (estimate)

May Core PPI released at 8:30am EST:  +0.3% (actual) vs. +0.2% (estimate)

FOMC policy announcement to be released at 2:00pm EST

Happy trading!

Tom

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Tom Bowley
About the author: co-founded Invested Central and served as the site's Chief Market Strategist for more than 10 years. His unique trading style combines both his fundamental and technical strategies to systematically manage risk while trading. A regular contributor to StockCharts.com's bi-weekly ChartWatchers newsletter since 2006, Tom's role at StockCharts has expanded significantly since he joined the company as a full-time Senior Technical Analyst in March of 2015. Learn More
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