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The outperformance of consumer cyclicals versus consumer staples is approaching the end of the line.
A good way to understand where we are in a stock market and economic cycle is to look at the relative strength of growth-oriented versus defensive sectors and groups. The concept is easy to grasp because it is self-evident as to why growth-oriented sectors should lead the way and have bigger traction both to the downside and the upside as significant bear or bull markets get underway, respectively.
There is no better pick for a growth-oriented sector than the consumer cyclical, aka consumer discretionary group. This group does best when the overall economy trends up and reflects and announces the consumer’s ability to spend discretionary money on all sorts of items we’d all like to spoil ourselves with but do not really need to have unless we can really afford them. For this group to do well the economy must do very well, with significant employment and wage growth emanating from an overall climate of increasing investment and spending.
At the other extreme the consumer staples group best represents the defensive end of the market. On a relative basis this group tends to do better than the discretionaries when we face certain economic difficulties. At that time we will give up on some of the luxury items we don’t really need but continue to buy products we always need such as food, beverages or personal goods. During bad times we’d cut on staples far less than we’d cut on discretionary items and that will show in the earnings of the companies from the two sectors: both will fall though the discretionary items will fall far faster.
The chart above is kind of self explanatory. The first quadrant shows you the XLY and XLP consumer discretionary and consumer staples ETFs plotted as a percentage from a starting point in 1999. Both ETFs sort of match the trend of the overall market although the XLY clearly has the higher Beta, which is what we’d expect: it does better than the XLP during the 2002-2007 and 2009-2018 uptrends, but it also does worse than the XLP during the 2000-2002 and 2007-2009 corrections.
These trends would obviously be seen in the XLY / XLP ratio shown in the 2nd quadrant. The interesting thing is that turning points in the ratio are coincidental with the S&P 500 in some cases or lead the way in other cases:
- The top of March 2000 intervened at the same time in the ratio and the broader market;
- The bottom of 2002 brought only a secondary low in the ratio, which had bottomed 8-9 months prior in September 2001;
- The ratio then topped in 2005 a full 2 years prior to the top in the market in July 2007. A double top formed in the ratio in July 2007;
- The ratio bottomed in November 2008, a full 5 months before the low in the market in March 2009;
- The ratio toped in January of 2011 before a small market top in July 2001;
- A big sideways correction then ensued in the ratio in February of 2014. The market subsequently started its own consolidation pattern in August of 2015, as the ratio was retesting its high.
Conditions at this time are such that the XLY / XLP ratio is showing some signs of fatigue. At this point the ratio is below the high established in June while the market has already beaten its corresponding level. In addition, the momentum high has been established early in 2018 and despite a rather significant rally in the ratio itself ever since, the current RSI reading is below that of January. These non-confirmations create the initial Dow Theory setups for an important reversal.
Pattern analysis in the XLP and XLY themselves suggests that the best part of growth is done in the XLY while the XLP must spot a final rally out of a 2 year consolidation pattern; this would mean that at some point the XLY will STOP making new highs while the XLP will make a few additional new highs before rolling over itself. Clearly, such a behavior would be consistent with that “peeling off” we normally see at big market turning points.
So from a long-term perspective, the ratio itself should thus be in a position to top soon. Based on strictly intuition at this point, we will propose a final high in the ratio should intervene anytime within the Q4 / 2018 – Q1 / 2019 range. We will have to confirm that upon getting more information from the market though the pieces we have as of today should suffice to keep us rather defensive between now and early next year. The important thing in the next little while will be to avoid getting too excited, particularly if you notice that everybody around you and their mother are getting very involved in the stock market or suddenly too optimistic. Historically, when the crowd noticed developments after multi-year uptrend it has never been a case of forward-looking visionary thinking and it has always been a case of trend-ending unanimity. I see no reason why it would be different in the current situation………[/vc_column_text][/vc_column][/vc_row][vc_row el_id=”PATTERN ANALYSIS”][vc_column][vc_column_text]
Pattern Analysis
S&P 500 Large Cap
The market is beginning to have difficulty reaching the channel line inside the uptrend channel from the July lows and this behavior normally is an initial indication of weakness. Pushes below the 2885 / 2859 key supports would thus be that much more significant if they occurred. Until a crackdown in the immediate uptrend can be confirmed, however, 2958 / 3031 remain logical targets / resistances.
S&P 400 Mid Cap
None of the support levels that would confirm completion of our rising wedge patterns gave way this week so our outlook is unchanged: the MidCaps would normally push – one last time ?? – within the 2050 – 2082 range before beginning a retreat below 2002 / 1970.
S&P 600 Small Cap
An initial support in the Small Caps at 1068 has been crossed to the downside but overall prices remain confined to the uptrend channel we started at the April lows. With a near-term USDollar low possibly in place we remain hopeful for an eventual push within the 1096 – 1120 range (confirmed above 1068-1078); though it is clear that a continuing slide below the 1053 / 1035 short-term key supports will open the door for at least a test of the 1006 / 976 zones.
Dow Industrials
We will maintain a cautiously positive outlook here too and say that a final rally within the 26753 – 27217 range will remain due if and only if prices remain above the 26156 / 25751 progressively more critical supports. Below those areas the Dow Industrials will get exposed to a deeper pullback towards 24,900 and then 23,900.
Dow Transportation
An initial crackdown has transpired in the Transports with the move below the 11411 support area. Additional weakness below the 11256 / 11128 critical supports would confirm a significant high has formed and prices were headed for 10950 / 10650 / 10215. Resistances for the eventual terminal leg up that can STILL develop before we break below 11256 – 11128 remains located at 11582 / 11815.
Dow Utilities
Some of our support levels have been pierced but the market is attempting to fight back. We can now identify resistance at 721 / 730 for an aggressive bearish case which has the utilities already sliding towards 680 / 650 (confirmed below 700-705). Back-up resistance, if somehow still needed, remains located at 747 / 761.
Russell 1000
UNCHANGED :::: The buoyancy of the large cap space and the relative quietness of the mid cap space are enough to push the Russell 1000 higher. We will tighten risk at 1589 / 1576 while allowing the RUI carry to the next objectives of 1643 / 1656.
Russell 2000
Some damage has already been done to the RUT with the push below 1700 and the move below the uptrend line that initiated at the April lows. But momentum remains confined to the normal limits of a downside correction and, at this point, so does price. We will thus allow RUT to carry higher above 1735 one last time (confirmed above 1720) but we’ll remain keenly aware that pushes below the 1652 / 1634 critical supports will confirm a more significant top has already been recorded.
Nasdaq 100
UNCHANGED :::::: REPEAT :::: The rising wedge appearance of the past few month’s rally is rather obvious. The NAS 100 is to remain supported at 7312 / 7163 if additional upside potential towards 7724 / 7851 is still due. Breaks below 7312 / 7163 must be treated as the beginning of a trip lower towards 6800 / 6500.
Nasdaq Composite
UNCHANGED :::: REPEAT :::::: The picture is identical with the NAS 100 though the levels are slightly different: key supports are located at 7723 / 7630 and then 7423 / 7333 while resistance for a terminal rally is located at 8146 / 8271.
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Weekly Stock Picks
AA
| DIRECTION | BUY ZONE | SELL ZONE | RISK/REWARD | VEHICLE |
| UP | $39-40 | $59-60 | -$1.00-$20.00 | STOCK/OPTIONS |
The Aluminum maker AA has been a roller coaster thus far in 2018. It has spent a good portion of the year putting in a falling wedge pattern which has fallen to the levels I have been waiting for – the lower bound of the value area taking into account one year of daily price history. We have bullish momentum making higher lows as well and I think we see Alcoa bounce at minimum back to the mid $42 and then beyond. Option Implied Vol is a bit on the elevated side so stock may be a better play unless you choose in the money calls. Earnings season kicks off when AA reports towards the end of October so in the immediate term I would play for a run up into earnings via options.
FNJN
| DIRECTION | BUY ZONE | SELL ZONE | RISK/REWARD | VEHICLE |
| UP | $4.20-4.35 | $6.00 | -$.10 – $1.70 | STOCK |
Cybersecurity cheapie stock $FNJN has already returned a near 100% gain in 2018 but I think it has gas left in the tank. We have a very simple bullish consolidation pattern that I think breaks out to the upside once finished digesting the recent gains. The one thing that attracts me to this stock is the strength of the move leading up to the pattern. In symmetrical triangles in particular, it is important to note what kind of move happened prior to the consolidation. In the case of FNJN you can see a swift move with almost no interruption higher after breaking out of the prior consolidation range. Pair that with very little downside risk and stock in FNJN is something on my buy list this coming week.
CAT
| DIRECTION | BUY ZONE | SELL ZONE | RISK/REWARD | VEHICLE |
| UP | $151.50-153 | $156-157 | -$1.00-4.00 | OPTIONS |
CAT after its most recent run higher and gap up on high volume has pulled back and is flagging near the price level where the strong buyers should step in to defend. Strong buy volume is often defended and I expect CAT to trade higher into earnings reported later this month. We can see signs of bulls defending on the two candles with lower shadows. I will be looking at options at the expiry just after earnings around the $155 strike early in the week.
INTC
| DIRECTION | BUY ZONE | SELL ZONE | RISK/REWARD | VEHICLE |
| UP | $46.25-47 | $54-55 | -$1.00-7.00 | OPTIONS |
INTC finally broke out of the falling wedge pattern which it had been forming for half of the year. It did so on heavy volume also confirming a move which I believe sticks. We know that oftentimes after price breaks out of a pattern, profit taking soon follows leading to a pullback near the site of the breakout. That is where we want to get long INTC and I think we get that chance this week. Options will be the play as Implied Volatility is low and earnings are on the horizon at the end of October. Look at the 47.50 or 48 strike calls on any pullback.
BITA
| DIRECTION | BUY ZONE | SELL ZONE | RISK/REWARD | VEHICLE |
| UP | $22-23 | $30-32 | -$2.00-8.00 | OPTIONS |
BITA has found itself in a downtrend in 2018 but most recently broke above the downtrend line as well as the volume point of control. Pair that with the long lower shadows on the candles from Thursday and Friday of this past week and I think we can plan on higher for BITA in the coming weeks ahead. This is a stock that can easily double in value from here so how you choose to play it is simply personal preference. Options are very cheap right now so you might look at a longer term play into year end via call premium. I own stock from just below these levels and am in for the long haul.
HEAR
| DIRECTION | BUY ZONE | SELL ZONE | RISK/REWARD | VEHICLE |
| UP | $18-20 | $34-35 | -$2.00-14.00 | OPTIONS |
HEAR is in the midst of a falling channel pattern that is supported by the one year VPOC on the downside. The allure of this trade is in its extremely defined support level just below the current traded price. The one year volume point of control (where the most shares have traded place this year) coincides with a 50% retracement from the annual lows to annual highs. We want to be long above this area of confluence and play for a breakout move from the channel. I’ll be looking at the October 20 strike calls this week.
BWXT
| DIRECTION | BUY ZONE | SELL ZONE | RISK/REWARD | VEHICLE |
| UP | $60-62 | $71-73 | -$2.00-10.00 | OPTIONS |
BWXT had been in a slow and steady uptrend in 2018 before taking the summer off to consolidate gains. It has formed a nice falling wedge pattern while the RSI has made higher lows. As this is not a stock I was familiar with I wanted to do some extra investigation. Part of the Nuclear industry group, it trades at a slightly lower P/E than its counterparts in the same industry group. Best case scenario, BWXT trades down closer to $60 and that is where we want to get involved from the long side. Options into November at the $60 or $65 strike will be the play. $65 if you plan to play aggressive or $60 strike if a bit more conservative.
CDK
| DIRECTION | BUY ZONE | SELL ZONE | RISK/REWARD | VEHICLE |
| UP | $60-62 | $75-76 | -$2.00-14.00 | OPTIONS |
A very similar look to BWXT, CDK has a defined falling wedge pattern which has retaken the 38.2% Fibonacci Retracement level of the rally which began in 2016. This level coincides with the VPOC giving us a level to work with to define our risk. I think we get one more low from which we can get long, playing for a breakout of the wedge and beyond. ATR is quiet so a move is on the horizon. A measured move out of the wedge pattern puts us back toward the highs for the year.
BA
| DIRECTION | BUY ZONE | SELL ZONE | RISK/REWARD | VEHICLE |
| UP | $371.50-373 | $430+ | -$1.00-60.00 | OPTIONS |
The chart of Boeing seems to be suggesting that a busted triple top is occurring as we speak. A triple top occurs when price trades into the same price level on three different occasions and then rejects lower. In the case of BA, we see price trade into the same level on three separate occasions, and instead of falling lower, price broke out on Friday above the resistance line. Old technical analysis textbooks would show that upon breakouts of busted triple top patterns, price will often make a swift 10% move higher above the breakout area. This would lead to a roughly $37 price move upward in a short period of time as traders begin to chase a stock that has new legs now that resistance has become support. To be safe I would wait and see what price does on Monday of this week. Should price trade higher we can be confident that there are more highs to come. We don’t want to see BA close back below the price level of the previous 3 tops.
BAC
| DIRECTION | BUY ZONE | SELL ZONE | RISK/REWARD | VEHICLE |
| UP | $29-29.50 | $32.50-33 | -.50-3.00 | OPTIONS |
Bank of America is putting in the classic breakout of a wedge and come back to retest the level of the breakout. In the market today, this pattern has become so common that opportunities are aplenty to play these breakouts from the long side, retests of the breakout zone from the long side, and even the retest from higher from the short side, although I haven’t perfected this yet. I have seen some of these patterns actually fall back into the top side of the wedge pattern so don’t panic if BAC dips back into the wedge. Some vicious rallies have come from a dip back into the top of the pattern. I like banks into the end of the year and I think this is setup just how we want to see it from the long side.
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