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Trend, Pattern, Group and Rank for Core ETFs – Breakouts, Mean-reversion Bounces and lots of Flags

There is broad strength in the equity-related ETFs with leadership coming from large-caps (SPY, QQQ), tech-related ETFs (IGV, SKYY) and even some more defensive names (XLP, USMV). Other defensive names extended their oversold bounces this week with XLU and XLRE moving higher. Stock alternatives, such as the 20+ Yr Treasury Bond ETF (TLT) and Gold SPDR (GLD), also bounced this week, but remain within falling wedge patterns.

There are two ETFs, in particular, to watch closely in the coming days. First, the Consumer Discretionary SPDR (XLY) is consolidating with the Bollinger Bands narrowing considerably. A break is imminent and AMZN could hold the key because it is the biggest component (22%). Second, the Internet ETF (FDN) has been lagging its tech-related brethren over the last few weeks because it remains stuck in a consolidation. The ETF bounced the last five weeks and I am watching for a breakout.

Elsewhere, there are lots of flags forming as a dozen ETFs work off their overbought conditions after big surges. In particular, I am focused on the Regional Bank ETF (KRE) and Bank SPDR (KBE) with their falling flags and pullbacks towards broken resistance. Similar patterns are taking shape in the S&P SmallCap 600 SPDR (IJR) and Russell 2000 ETF (IWM), while the S&P MidCap 400 SPDR (MDY) sports flat flag.

Grouping and Ranking Methodology

There has been a bit of confusion on the ETF grouping and ranking reports so I will try to clarify. This report is designed to group the ETFs by their chart patterns, setups and trends. These variables are dynamic and will not be the same every week. There are big consolidations, breakouts, small consolidations, corrective patterns, overbought breakouts and messy uptrends. I am trying to group like with like based on the price chart.

Once these groupings are in place, I then rank the groups based on my assessment of their overall strength. Yes, it is a bit subjective. ETFs hitting new highs this week are at the top, while ETFs trading near new lows are at the bottom. This week I am putting the “trend resumption breakouts” in several tech-related ETFs near the top because they are leading the last seven weeks. The bond and precious metals ETFs are in the lower half because they declined since September and underperformed the last seven weeks.

1) Consolidation Breakout & New High: SPY, QQQ, XLK, XLC, XLV, XLB, ITA, IHI

2) Trend Resumption Breakout: SKYY, HACK, FINX, IGV, IPAY, FDN?

3) Consolidation Breakout: USMV, XLP, KIE

4) Flat Flag/Pennant: MDY, RSP, XLI, SOXX, ITB, XHB, EFA

5) Falling Flag: IJR, IWM, XLF, BOTZ, KRE, KBE

6) Strong Breakout, but Overbought: IBB, XBI, IHF

7) Oversold Bounce within Uptrend: XLU, XLRE, IYR, PFF, UUP

8) Stuck in Consolidation: MTUM, XLY, HYG

9) Falling Wedge Correction: GDX, GLD, SLV, AGG, TLT, LQD

10) Messy Chart and Emerging Uptrend: XRT, REM, IEMG

11) Downtrend: XLE, TAN, MJ, FCG, XES, XOP, AMLP, REMX

Note that I am working on a ranking and rotation system using these 60 core ETFs. Finding a robust system that produces decent returns with manageable risk is a tall order, especially when dealing with ETFs. In addition, I must not over-fit the system and keep it fairly simple. It seems that trend following and rotation systems are better suited for stocks because ETFs often lack the big gainers needed to make the system work. In any case, I will persevere and report back in the coming weeks.    

Consolidation Breakout and New High

  • SPY, QQQ, XLK, XLC, XLV, XLB, ITA, IHI

The S&P 500 SPDR (SPY) and Nasdaq 100 ETF (QQQ) are among the leaders as both recorded new highs this week. These two are pretty much my main litmus test for the broader market. We are in some sort of a bull market when these two record new highs.

Both developed similar patterns as they hit new highs in July, consolidated into October and broke out to new highs. A consolidation after a new high is a bullish continuation pattern and these breakouts simply signal a resumption of the bigger uptrends.

These two are still quite extended after 8-10% advances the last seven weeks (35 trading days). Nevertheless, their short-term uptrends remain in place, even after Thursday’s small decline. I will update the short-term uptrend analysis for SPY in Friday’s report.

Will we get the pullback or pause that refreshes? As noted below, we are already seeing a pullback in the S&P SmallCap 600 SPDR and some industry group ETFs. SPY and QQQ, in the words of Tom Petty, are saying: No, I won’t back down.

Tech-Related ETFs Resume Uptrends

  • SKYY, HACK, FINX, IGV, IPAY, FDN?

The resurgence of the tech-related ETFs remains a big story over the past month and past week. The Technology SPDR (XLK) performed just fine without them this summer, but is now getting help from these groups and this should keep the Technology sector strong. Keep in mind that XLK is by far the biggest sector in the S&P 500 (22%).

HACK is the big leader over the past month, but we are also seeing good gains in IGV, SKYY, FINX and IPAY. These ETFs led the first half of the year, underperformed and corrected from July to September, and broke out in October to reverse their corrections. We have a classic two steps forward and one step backward sequence at work. More importantly, the October breakouts signal a resumption of the two-steps forward and this argues for new highs in the coming weeks and months.

The Internet ETF (FDN) has been singled out because it has yet to break out. Nevertheless, it is showing signs of life with a bounce off consolidation support. As with the other tech-related ETFs, FDN also sports the two steps forward and one step backward sequence with a big advance, 50% retracement and falling wedge. A move above 137 would trigger a consolidation break and this would be the first step towards a trend resumption.

Consolidation Breakout

  • USMV, XLP, KIE

Even though it seems like the offensive groups are taking over, many of the defensive groups are holding up just fine and some are even breaking out. The S&P 500 Minimum Volatility ETF (USMV) and Consumer Staples SPDR (XLP) are within 1% of 52-week highs with triangle breakouts. They are lagging because their advances over the last seven weeks (~2.8%) are not as big as the advances seen elsewhere.  Nevertheless, their price charts are bullish as they hit new highs in August, stalled into October and broke out here in November.

Flat Flag/Pennant

  • MDY, RSP, XLI, SOXX, ITB, XHB, EFA

Now we get into the ETFs that became short-term overbought and consolidated with flat flags, pennants or falling flags of some sort. These are short-term bullish continuation patterns that work off overbought conditions after a strong move. The flat flags and pennants represent a simple sideways consolidation where buying and selling pressure equalized. The falling flags reflect more selling pressure because prices declined. Technically, the flat flags and pennants show less selling pressure because prices moved flat. This means they are a bit stronger than the ETFs with falling flags.

The first chart shows MDY with a 7.5% surge, triangle breakout, 52-week high and flat flag. The triangle breakout and 52-week high are long-term bullish, as is the momentum thrust from early October to early November. Short-term, the ETF traded flat for two weeks and worked off some of the overbought conditions. A flag breakout would signal a continuation higher and argue for a 5-7% move.

Flags can be tricky to trade because they are prone to whipsaw. Notice the June surge and failed flag in early July. This is something we need to prepare for and not be surprised if it happens. Plan your trade before you make it and trade the plan.

In contrast to a flat flag, IJR sports a falling flag. Thus, over the last two weeks we saw SPY extend its gain (+1.22%), MDY trade flat (-.11%) and IJR edge lower (-1.42%). Once again, large-caps are holding up better than small-caps. Even so, IJR remains in an emerging uptrend with a higher high and higher low defined by the blue trendlines.

IJR surged some 9% from early October to early November and then edged lower with the falling flag. This decline pushed RSI back to the 40-50 zone and this is the first place to watch for a bounce. A break above 81.5 (red line) would reverse the falling flag and signal a continuation higher.  

The Home Construction ETF (ITB) chart shows a steady uptrend from late December to late October and a pennant consolidation the last few weeks. A breakout at 45.5 would signal a continuation higher. This chart also highlights a falling flag in late January and a messy breakout in early August. ITB surged above resistance in early January and then fell back below resistance in late January. This was NOT a failed breakout because a pullback after a 19% surge is perfectly normal. The lesson here is not to get caught up in the failed breakout fallacy.

The second lesson is not to expect a clean breakout and immediate resumption higher. The Ascending Triangle breakout in early August did not hold until the third attempt. The market is here to trip you up and the chance of tripping is greater when we focus too short-term. Again, don’t get caught up in the daily noise and stay focused on the bigger patterns at work.

Falling Flag

  • IJR, IWM, XLF, BOTZ, KRE, KBE

The falling flags in the Regional Bank ETF (KRE) and Bank SPDR (KBE) are worth watching because the Finance sector is the biggest sector in IJR (17.62%) and IWM (17.91%). Finance is the second biggest in MDY (16.7%) and the third biggest sector in SPY (13.12%). Yes, banks and financial institutions still hold some sway in the major index ETFs.  

KRE and KBE have similar patterns at work, both long-term and short-term. Both broke out of big falling channels in October and reversed six month downtrends. KBE is slightly stronger because it recorded a 52-week high. The bigger trends are up for both and this is positive for the broader market

Short-term, both surged around 13% from early October to early November and then corrected with falling flags the last two weeks. KBE is also holding up a little better on the pullback. Both are just above their breakout zones, which mark support. RSI is also just above 50. An ideal setup would see both return to their breakout zones and RSI dip in the 40-50 zone. However, Mr. Market does not always give us the ideal setup. Keep an eye because these two ETFs are nearing a point where buying pressure could increase and trigger flag breakouts.

Strong Breakout, but Overbought

  • IBB, XBI, IHF

The Biotech ETF (IBB +17.2%), Biotech SPDR (XBI +16.4%) and Healthcare Providers ETF (IHF +21.4%) continue their sharp reversal of fortune by moving from down-trending laggards to momentum leaders in a mere seven weeks. IBB and XBI hit 6 month lows in October, while IHF hit a five month low. I did not see these big moves or breakouts coming because they were lagging when the moves started. This is ok because we cannot catch them all.

IBB was up 10% and RSI was above 70 when it broke out on October 22nd. It then added another 6.4% and became even more extended. Such is life in the fast lane. I am not a chaser and will keep IBB on the watch list for a suitable setup in the coming weeks (same for XBI and IHF). Broken resistance turns first support in the 106 area.  

Oversold Bounce within Uptrend

  • XLU, XLRE, IYR, PFF, UUP

The Utilities SPDR (XLU) and the other defensive ETFs above are still in long-term uptrends. They hit new highs in September or October and remain above their 200-day SMAs. They are lagging because they fell back when the broad market (SPY) advanced to new highs. They are still lagging overall, but getting oversold bounces as RSI moved above 30 last week. Chartists looking for an exit strategy on this bounce can use this week’s low to set the initial stop and then trail it should the advance extend.  

Stuck in Consolidation

  • XLY, HYG

The Consumer Discretionary SPDR (XLY) and High-Yield Bond ETF (HYG) are in uptrends overall, but have gone nowhere since August. XLY is lagging because it did not reach its September high in October. Nevertheless, some sort of consolidation is unfolding and it could even be an Ascending Triangle, which is a bullish continuation pattern. The range is narrowing as the Bollinger Bands narrowed and BandWidth hit a 52-week low. Watch 123 for an upside bullish breakout and 119 for a downside break.

HYG is lagging because it is flat the last seven weeks and down slightly the last three weeks. Junk bonds are supposed to act more like stocks, but they are not keeping pace as HYG remains short of a breakout. Even though HYG moved below its 200-day, I would prefer to focus on the fact that RSI is near 30 and the ETF is getting short-term oversold. These conditions could pave the way for a bounce.

Falling Wedge Correction

  • GDX, GLD, SLV, AGG, TLT, LQD

The precious metals and bond ETFs have similar chart patterns at work: big advances from April to August, new highs in August and falling wedge corrections since September. How do we know when a correction turns into a bigger downtrend? We should first ask if the current declines still look corrective. Yes, they do.

This is the same logic that was applied to FINX, IPAY and IGV in October. These three were underperforming and in multi-month downtrends, but the declines still looked corrective in nature. Think two steps forward and one step backward. The first chart shows GLD with a falling wedge that retraced around 38% of the prior advance. RSI touched 30 on 11-Nov for the first oversold reading since April. It took GLD another month to fully stabilize then and the breakout did not occur until June. Technically, the trend is down as long as the wedge falls and a break above the early November high is needed for a full reversal.

The overall structure of the 20+ Yr Treasury Bond ETF (TLT) chart is bullish with the 25% surge and 50% falling wedge pullback to the 134 area. TLT is one of the market leaders over the last seven days with a 4.15% bounce, but still a laggard over the last seven weeks. The ETF is now poised to challenge the early November high and a break here would be bullish for bonds (bearish for yields).

Messy Chart and Emerging Uptrend

  • XRT, REM, IEMG

Some charts do not have much structure to their trends and are just too messy to analyze/trade. I put the Retail SPDR (XRT) in this group as the ETF trended lower until August and then trended higher the last three months. An emerging uptrend is possible, but XRT remains below its spring highs and near its flat 200-day SMA. We can hardly call this a steady uptrend and clear chart. Pass!

Downtrend

  • XLE, TAN, MJ, FCG, XES, XOP, AMLP, REMX, XME

9 of the 60 ETFs in this core ETF list are in downtrends and on my avoid list. These ETFs cover energy, metals, marijuana and solar. I showed the XLE chart on Saturday with a bull flag forming after the bounce off support, but there was never a breakout as XLE fell sharply on Tuesday and Wednesday. The overall downtrend is the dominant force at work in XLE, and the other eight ETFs. We, as traders, have a choice. We can either focus on bull flags within bigger uptrends or bull flags within bigger downtrends. Thinking ahead to the next 1000 trades, I think a bull flag within a bigger uptrend has the better odds.

That's it for today. Thanks for tuning in!