Not So Fast There, Cowboy – The Reflation/Value Trade Gets Cold Feet

Small-caps and banks went from potential leaders to potential failures over the past week. Basically, the markets got cold feet on the reflation/value trade and bailed the last two days. I do not know if this is just pre-election jitters, but there are a lot of BIG unknowns out there right now. These include the uneven rebound in stocks, election, covid, lockdowns, QE and fiscal stimulus, to name a few. Right now the election is the elephant in the room and traders may be putting off new bets until this event passes.

Now let’s look at some of the failures that are brewing in small-caps, Industrials, Finance and banks.

Equal-weights Fail at Resistance

Even though a bullish Ascending Triangle is still possible, the price action in the S&P 500 EW ETF (RSP) is not inspiring as it failed at resistance with a gap down. RSI gapped down on Monday and closed off its low. The ETF opened flat on Tuesday and closed near its low. Thus, the gap is short-term bearish and considered a breakaway gap. The flat-to-falling 200-day and September low mark key support.

Relative Performance Breakout in IWM On Hold

We are also seeing failures in a number of bull flags. The chart below shows the Russell 2000 ETF (IWM) going for a breakout on Thursday-Friday, only to be rejected on Monday-Tuesday. Flags are short-term patterns that are vulnerable to whipsaws when trading turns choppy. Long-term, the trend is up with support in the low 140s.

With small-caps turning back at resistance, the relative performance breakout is back on hold. A break back below the 200-day would show small-caps lagging again.

Industrials and Finance Sectors Get Cold Feet

The Industrials SPDR (XLI) was one of the leading sectors in mid October because it broke above its September highs. XLI stalled after breaking the consolidation zone and fell rather hard the last two days. Again, we are seeing a gap down on Monday and follow through on Tuesday.

The Finance SPDR (XLF) sports a failed pennant breakout and a decline back below the falling 200-day SMA. XLF also failed to take out its September high and has been lagging year-to-date. The failed pennant, Monday gap and Tuesday decline suggest that the short-term uptrend reversed and a triangle break would follow.

Regional Bank ETFs Give Back Big Surge

And what about the Regional Bank ETF (KRE)? KRE broke out of a falling flag on October 16th and exceeded its August high. KRE held up well on Monday with a small decline, but got hit hard on Tuesday with a sharp decline that gave back all the gains from Thursday, which is when KRE surged above its 200-day. Traders playing the flag breakout can note the ATR Trailing Stop at 40.04. The flag low marks support from the most recent reaction low.

Also note that the surge from September 24th to October 23rd is starting to smack like the one from May 14th to June 5th. KRE was suddenly looking like a leader in early June and then fell into a slump with a falling wedge into September.

We can also include the S&P MidCap 400 SPDR (MDY), S&P SmallCap 600 SPDR (IJR), Aerospace & Defense ETF (XAR), Mortgage Real Estate ETF (REM) and US Oil Fund (USO) on the failure list. The Semiconductor ETF (SOXX) is above its 50-day SMA, but fell ten of the last eleven days.

We can expect above average volatility from now until the election outcome. The long-term trend for the S&P 500 is still up and the breadth models have yet to trigger bearish. The failures in the groups shown above are a concern and I will be watching to see if this selling pressure spreads.

Thanks for tuning in and stay safe.

-Arthur Hill, CMT
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