This Week's Publishing Schedule
This week’s commentary schedule will be a bit different because I go in for a non-invasive procedure on Wednesday (12-Jan). My overall health is good, but DNA and age (59 years) are calling. The procedure, which is quite common, is a Holmium laser enucleation of the prostate (HoLEP). I will go under a general anesthesia and should spend one or two nights in the hospital.
Next Week’s Schedule:
Monday, 10 January: Strategy Article/Video
Tuesday, 11 January: Market/ETF Commentary and Video
Saturday, 15 January: Weekend Video? (depending on recovery)
Frankenstein ETFs
In an ideal world, trends would be consistent and persist for months. An ideal uptrend would march higher by consistently recording higher highs and higher lows. Once reversed, a downtrend would take over and work its way lower with lower lows and lower highs. There are plenty of chart examples for these consistence and persistent trends.
Unfortunately, there are also plenty of examples where the trend is inconsistent or non-existent. As chartists, we want to focus on trends with the most consistency and avoid trends with the least consistency. Easier said than done. Today’s article will look at some different trends and show how to separate consistent uptrends from inconsistent trends. We will also show some techniques for identifying tradable pullbacks along the way.
The chart above shows QQQ with the Trend Composite in the first indicator window and StochClose in the second window. The green/red arrows on the chart show StochClose signals. These two indicators generate similar signals. They make money when price trends and lose money (whipsaw) when price does not trend. The trends in QQQ were strong and would have contributed hansomely to a trend-following strategy.
Frankenstein ETFs
Truth be told, it is easier to find individual stocks with consistent trends, than it is to find ETFs with consistent trends. A stock trend is based on one price trend, whereas an ETF trend is based on the trends of its component stocks and the weightings of these component stocks. QQQ is dominated by the top seven stocks and shows more trendiness because large-cap tech stocks have a strong positive correlation.
In contrast, the Industrials SPDR (XLI) is a Frankenstein ETF because the industry groups do not always correlate. Industry groups in XLI include Machinery (19.9%), Aerospace & Defense (18%), Industrial Conglomerates (13%), Road & Rail (11.6%), Air Freight & Logistics (8.2%), Building Products (6.3%), Electrical Equipment (6.8%), Professional Services (5.3%), Commercial Services (5.1%), Airlines (2.8%) and Trading Companies (2.5%). The PerfChart below shows six month performance for XLI and the 11 groups.
Machinery, Building Products and Electrical Equipment are the pure plays on the industrials sector. Aerospace & Defense is driven by government spending more than the economy. Road & Rail are lumped together, but the trucking business is completely different than running a railroad. Professional and Commercial services are service businesses, as opposed to manufacturing. Airlines are also service businesses that are incredibly cyclical. Overall, XLI is just a hodgepodge of industry groups and this can affect trendiness.
The chart below shows XLI with two good uptrends over the last six years (green arrows). These two big moves coincided with broad bull markets that lifted all boats (2016-2017 and March 2000 to May 2001. The blue shadings show periods when XLI was flat and the red shadings highlight two downtrends, which were sharp and short. Overall, XLI showed a consistent uptrend around half the time and this has more to do with broad market conditions than anything else. The rest was chop or downtrend.
Perfection Does Not Exist
I have searched far and wide for an indicator that can measure a consistent and persistent uptrend. This search includes zillions of indicator builds and backtests. I regret to inform you that the perfect trend indicator does not exist, but we already knew that. Even so, trend indicators are good for generating systematic trend-signals as part of a trend-following strategy and filtering in scans to exclude stocks or ETFs that are in downtrends.
Most of the time we can just look at a chart and immediately assess the trend: Up or Down or Flat. Furthermore, we can tell if the trend is consistent, persistent and steady, as opposed to inconsistent, sporadic and choppy. There are many degrees of trend.
The chart below shows the Global Carbon ETF (KRBN) with perhaps the most consistent and persistent uptrend for 2021. The consolidations were short and the pullbacks were shallow as the ETF advanced from 25 to 50 over a 12 month period.
The indicators confirm the shallowness of the pullbacks. The Momentum Composite dipped to -2 in October and that was the most oversold reading of the year. RSI dipped below 40 just once when it turned red in mid July. This is an oversold condition. RSI also dipped into the 40-50 zone several times throughout the year and this shows a very mild oversold condition (turned blue).
A Picture of Consistency
The next chart shows the Healthcare SPDR (XLV) with a consistent uptrend with “normal” pullbacks along the way. This uptrend is consistent because XLV regularly recorded higher highs and higher lows. In addition, the pullbacks after the higher highs retraced 50 to 67 percent of the prior advance. This is a classic two steps forward and one step backward sequence. XLV hit a new high at yearend and is currently in the pullback phase of the consistent uptrend. This is the type of chart we want on our watch list.
The indicator window shows the Momentum Composite and the green arrows on the price chart show when the indicator dips to -3 or lower. A dip to -3 alerts us to a short-term oversold condition, but such a dip does not always mark the low of the pullback. Sometimes the oversold alert is very close to the low, but stocks and ETFs sometimes remain short-term oversold and correct for a few weeks.
XLV vs XLI
Now lets return to the XLI chart. XLI sported a consistent uptrend from June 2020 to July 2021 with higher highs and higher lows on a regular basis. There was a breakout in August 2021, but this breakout failed and the uptrend lost its consistency with the September decline (yellow shading). XLI has been flat since May.
Consistent, but Choppy
The next chart shows the Finance SPDR (XLF) with two different uptrends. The first was very consistent, but also very steep and unsustainable (Oct 2020 to May 2021). The second uptrend started in June and is more choppy. Nevertheless, we can see higher highs and higher lows on a regular basis. This uptrend is considered choppy because XLF was below its June high in December (blue line).
No Trend
The next chart shows the Gold SPDR (GLD) with a trading range since June (larger triangle). This range is abundantly clear on the price chart and GLD would not make the cut for a consistent uptrend. The Trend Composite and StochClose indicators are both whipsawing with multiple signals over the last seven months. Flip that coin!
Lost Consistency and Reversed
The next chart shows the Software ETF (IGV) with an uptrend from spring 2020 to late 2021 (+150%). The Trend Composite remained bullish during the entire uptrend, but StochClose got a whipsaw from March to May 2021. Of note, IGV did not break below the prior low during the two 3-month stalls. Thus, these were corrections within the bigger uptrend. The trend lost some of its consistency for two to three months, but did not reverse.
The current decline in IGV is different because the ETF broke the October low and both trend indicators turned bearish. At the very least, IGV lost trend consistency and would not make the watch list. The October low was a benchmark low that we were watching in November and December. ETFs that broke this low were leading on the downside and reversing their uptrends (FDN, FINX, SKYY, XLC).
Uptrends with Long Periods of Flat Trading
The Consumer Staples SPDR (XLP) and Utilities SPDR (XLU) are two sectors we might consider when the stock market is looking shaky. These two charts do indeed sport long-term uptrends (based on visual price chart analysis). The trend indicators, however, show whipsaws along the way. XLU shows a long rising channel since spring 2020, but there are some long periods of flat trading (4, 9 and 13 months). Buy and hold worked, but buying breakouts and new highs would have been frustrating. The XLP chart is similar.
Chartist have a Choice
The main point here is to remember that we can choose where to focus. Would you rather focus on XLV with a consistent uptrend or XLI with a flat or inconsistent uptrend? I know my answer. Is GLD worth the effort with a choppy trading range? Probably not. XLU and XLP are still trending higher and have better looking charts that IGV. However, both are prone to long periods of flat trading.