The Relative Rotation Graph below holds the sector ETFs that make up the S&P 500 universe and uses the S&P 500 index ETF (SPY) as its benchmark in the center of the graph.
Four rotational patterns, two pairs, capture my attention when I look at this chart.
Summary
- Financials and Health Care at opposite extremes
- Relative momentum on both sectors (XLF & XLV) rolling over creates opportunity
- Materials and Technology rotating in opposite directions and about to turn relative trend around
Quick scan
The first look at this RRG drags my eyes to the extreme position, far away into the top-right quadrant, of the Financials sector XLF. Then scanning the area opposite of XLF, deep inside the lower left, lagging, quadrant shows a cluster of three sectors. Further inspection reveals that the sector which tail has started to move higher on the JdK RS-Momentum scale and just moved to a heading between 0-90 degrees is Health Care (XLV).
This combination XLV/XLF deserves some more study as it could be a very interesting rotational pattern. Probably not for the faint of heart as both sectors are at pretty extreme values given the "normal" rotational patterns within this universe but sometimes you have to be a bit more adventurous.
The second pair of rotations that I want to study further is XLB/XLK. Materials, XLB, has just crossed over into the lagging quadrant, signaling the early stages of a relative uptrend against SPY while Technology, XLK, is about to cross over into the lagging quadrant and confirm its recent weakness against SPY.
Financials and Healthcare
The second RRG above magnifies the relationship of the rotation between XLF and XLV over the past 20 weeks. As you can see they have moved almost perfectly at opposing headings and both, start to roll over and lose relative momentum.
Financials start to lose positive (relative) momentum while Health Care began to lose negative (relative) momentum.
Based on their positions on the Relative Rotation Graph, Far away from the benchmark, at the extremes of the universe, the RRG clearly indicates strong but mature relative trends for these sectors.
From a trend following perspective, there is not much to say yet for either one of them, but when we put them against each other, some trend ending characteristics are showing up which could make this an interesting trading idea.
Financials Select Sector SPDR Fund - XLF
After breaking the barrier around $ 20, the Financials sector rallied strongly. The inverted H&S pattern (indicated on the long term chart below) seems to have worked its magic.
The result of this strong move in price on the relative strength of XLF against SPY is visible in the two lower panes. The RS-Line (black line in bottom pane) has crushed an important horizontal resistance area which also shows up on the longer-term version of the chart below.
This is an important long-term signal and suggests that Financials could be in for a longer period of outperforming the general market (SPY). BUT, not in a straight line.
The longer term chart of XLF vs. SPY is probably better suited to show what I mean.
The break above its important long term resistance level is, again, clearly visible in the bottom pane and this chart also shows that the same level has acted as support a few times before 2012. An important level, no doubt.
On the price chart, I have drawn a long-term rising channel. The support line is very reliable with five touching points. The parallel line can be drawn at two different levels which creates a rising resistance zone. At the moment XLF is stalling in that zone.
Additionally, that zone coincides with the target based on the inverted H&S pattern ($ ~2.50 - 3.00 above the breakout level). This means that XLF has now plenty of room to drop back to lower levels, $ 20 makes a good support level, and the lower boundary of the channel is just below that, without harming the longer term uptrend. The potential magnitude of such a move makes it worthwhile looking and maybe positioning on it.
The "over stretching" is also quite visible in the RRG-Lines where the JdK RS-ratio line has reached levels that are way beyond the "normal" high values for XLF inside this universe. When relative momentum continues to support such a move to "high" values it only means that the trend is very strong and we should not argue with it. But recently JdK RS-Momentum has started to roll over (btw also at extremely high values based on historical readings) causing the tail of XLF on the RRG to curl down.
Again, these are all still strong, and positive readings for the relative trend but the magnitudes of the moves in both price and relative strength make it an interesting counter-trend trading opportunity.
Health Care Select Sector SPDR Fund - XLV
The Health Care sector did not push to new highs yet like Financials. The sector peaked around $ 75 back in 2015 already and has not been able to push higher yet. The $ 75 level was tested as resistance again in the middle of 2016, but it failed to break higher.
The drop off of this resistance test has recently put in a new low just above $ 65 which is greater than the previous low near $ 62.50. This is a mild, positive. Especially as we can no start to pencil in a new rising support line, connecting the lows since mid-2014.
The relative picture is profoundly affected by the flat performance of Health Care since mid-2015 and shows a strong downtrend. The longer-term chart of XLV above reveals that the RS-Line against SPY is now nearing an area that has served as both support and resistance in the past.
More importantly, the RS-Ratio line is hitting levels where relative strength declines tended to turn around or, at the minimum, stall for a while.
Just like for the Financials sector it is the potential magnitude of a counter-trend move that makes this an attractive sector to keep an eye on for a temporary, jump higher in relative terms.
Financials / Health Care - XLF / XLV
Following the charts and observations above there is one chart that needs attention. Obviously, that is XLF against XLV directly, instead of both sectors against SPY.
Focussing on the lower two panes of the chart above we can see the direct relation of Financials against Health Care. As you can see the RS-Ratio line has reached its highest level since the start of trading of this ETF while RS-Momentum is, gently, starting to roll over.
Supporting, at least a temporary, rotation out of Financial stocks into Health Care is the fact that the RS-Line is hitting a horizontal resistance barrier which will likely prevent a further rally right away.
Let me stress that trading Health Care against Financials is nowhere near a trend following trade. As a matter of fact, it is the opposite, but it seems a good possibility as relative strength measures for both sectors are overstretched and at extremes on every possible reading which makes a counter-trend move likely but certainly no guarantee!
Materials and Technology 
The second pair of sectors that are making up an interesting rotational pattern are Materials and Technology (XLB and XLK). Especially the Materials sector already came up in the previous blog post on US sector ETFs as promising.
The RRG above zooms in on the rotations of these two sectors showing 20-week tails. They move(d) almost perfectly opposite of each other. Assuming that such a rotational pattern continues a shift out of Technology into Materials seems the way to go at the moment.
The chart above shows the RS-Line and the RRG-Lines of XLB vs. XLK. The downtrend in the RS-Line is still in play and RS is pushing against the falling resistance line.
It's the recent break of XLB above heavy resistance in the price chart that makes this a potentially interesting trade idea. XLK broke above its 2015-2016 highs already a few months ago and has started to lose momentum and hit the top of its channel.
The RRG Lines have already started to pick up on the improvement in this relationship, and they are suggesting that a new uptrend (favoring XLB over XLK) is starting to get underway.
A break above its falling resistance line in the RS-Line will probably give the confirmation and cause an acceleration of the relative rotation in favor of Materials.
Julius de Kempenaer | RRG Research
RRG, Relative Rotation Graphs, JdK RS-Ratio and JdK RS-Momentum are registered TradeMarks by RRG Research
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