The next report will be posted on Tuesday, August 29th.
Today’s report will show two more examples using the Momentum Composite and StochRSI. The Momentum Composite identifies oversold conditions and StochRSI signals a subsequent momentum pop. Chartists can also look for short-term resistance breakouts if there is a clear resistance level. Today’s examples will be with two defensive sectors (XLU, XLP). I am focusing on these two because the market is looking rather shaky as we head into September. Also note that these two sectors are defensive and have the lowest correlations with SPY.
XLU Has the Lowest Correlation of the 11 Sectors
The first chart shows the long-term picture for the Utilities SPDR (XLU). The windows show the price chart, the 10-yr Treasury Yield, the XLU:SPY ratio and the 1-year correlation with SPY. XLU advanced with the rest of the market from the March 2020 low and hit a new high in mid August 2022. This new high was roughly equal to the spring high and a large Double Top formed. XLU confirmed this bearish reversal pattern with a break below the intermittent low in October 2022. The ETF went on to form a large Symmetrical Triangle and broke triangle support here in August to signal a continuation of the long-term downtrend.
As the first indicator window suggests, XLU ran into trouble when the 10-yr Treasury Yield exceeded 4% in October. SPY also bottomed in October as other sectors attracted buying interest. XLU is a risk-off defensive sector. The third window shows the XLU:SPY ratio falling since October as XLU underperforms the broader market. The last window shows the 1-year Correlation Coefficient at .65, which is the lowest of the 11 sectors. For reference, the Technology SPDR (XLK) is .93 and the Consumer Discretionary SPDR (XLY) is .90. A Correlation Coefficient of 1 means perfect correlation with SPY and these two have the highest correlations of the 11 sectors.
Even though XLU has the lowest correlation with SPY (.65), it is still positively correlated with SPY and vulnerable to broad market swings. XLU outperforms SPY during broad market downturn because it declines less or trades flat. I am featuring XLU today because of deteriorating conditions in the broader market. These include the percentage of stocks above their 200-day SMAs, the breakdowns in Banking and Retail, and serious relative weakness in mid-caps (MDY) and small-caps (IWM).
XLU Becomes Oversold and Gets a Pop
XLU is in a long-term downtrend, but it trades very choppy and is setting up for an oversold bounce. The next chart shows XLU with the Momentum Composite and StochRSI(10). The Momentum Composite identifies oversold readings with a move to -3 or lower. A subsequent StochRSI pop above .80 signals a short-term momentum thrust (green arrows). Caveat emptor: signal examples (theory) always look pretty good, but trading reality can be different!
The chart below shows losing signals in early October 2022 and mid February 2023 (red loss). The signals in mid October 2022, early March 2023 and late May 2023 led to further gains. Notice that there were price throwbacks after each signal (blue arrows). The March and June throwbacks tested the lows just prior to the StochRSI signals. Because of these throwbacks, the ATR Trailing Stop would not have worked.
The blue dotted lines mark a 5% gain from the open after the StochRSI pop. When it comes to short-term trading, I am a fan of profit targets and a 5% profit for an ETF is pretty good.
XLU is currently setting up because the Momentum Composite became oversold in early and mid August. StochRSI popped above .80 on Wednesday for a short-term momentum thrust. Monday’s low marks support at 62.58 and a close below this level would negate the signal. Chartists can also watch for a short-term resistance breakout at 64 for a signal.
XLP is Long-term Range Bound
The next chart shows the Consumer Staples SPDR (XLP) since January 2020. The ETF broke support in May 2022 and then moved into an extended trading range (blue shading). There is no trend here. The third window shows the XLP:SPY ratio falling since January, which is when the risk-on trade really kicked in. The bottom window shows the 1-yr Correlation at .74.
XLP Gets Oversold Setup
The next chart shows the Consumer Staples SPDR (XLP) with the Momentum Composite and StochRSI. The first three StochRSI signals (green arrows) did not work because XLP closed below the low prior to the signal (stopped out). October resulted in an ugly whipsaw as XLP surged soon after “breaking” support. The March signal worked and XLP hit the 5% profit target. XLP advanced after the May signal, but did not hit the 5% profit target.
The StochRSI pops did not work well here. Chartists can also consider waiting for a short-term breakout, should a clear resistance level form. The red lines mark short-term resistance levels and we can also see breakouts in late October, late March and mid June. The early January close was not above the high and there was not breakout then.
XLP is currently setting up because the Momentum Composite became oversold in mid August and StochRSI has yet to pop. A pop above .80 would provide the first sign of upside momentum. XLP does not have a clear resistance level to work with right now.