The current rotations within the S&P 500 sectors to start the New Year (2020) paint a rather mixed technical picture about the economy and about the mindsets/psychology of the investment crowd. Except for the continued strength of the S&P 500 Technology sector (XLK) it appears many investors are struggling to determine the emergence of new leadership sectors.
We decided to review the Relative Strength Graph (RRG) chart over the past 8-weeks ending on 1/27/20 and delve deeper into the underlining forces that may be leading to the rotations taking place in the U.S. stock market. This is the summary of our technical findings on the 11 S&P sectors:
Leading Quadrant: S&P Technology (XLK) and S&P Healthcare (XLV)
The two S&P 500 sectors currently reside in the leading quadrant (S&P Technology and Healthcare) are clearly diverging from each another.
Technology (XLK) continues to extend its strong relative strength/relative price momentum moving further out to the right and to the top of the leadership quadrant. Traders and investors have performed well with an overweight in this sector. As you can see from the enclosed chart of XLK a positive outside day on 1/30/20 bodes well for the continued outperformance of Technology over the near-to-medium term. However, an extreme overbought condition will likely develop in this group resulting in a correction.
Healthcare (XLV) is beginning to show visible signs of weakness. After spending the past two months entrenched within the leading quadrant, XLV has declined sharply over the last 2-3 weeks, as evidenced the precipitous drop in its relative price momentum trend. This suggests an overbought condition that often leads to a corrective phase. In addition, a second gap down on 1/30/20 warns of further volatility in this group. XLV is now testing its 50-day ma (101). A successful test of its key near-term support may help stabilize the recent selling. However, violation of this key support zone warns of a deeper and more extensive correction toward major support at 92.5-93.5 coinciding with the 200-day ma and the extension of the late-Oct 2019 technical breakout. It would take a sizeable drop in relative price momentum and relative strength to move this sector into the weakening quadrant.
Weakening Quadrant: S&P Financial (XLF)
We suspect the recent sharp decline in U.S. interest rates (yields) and a moderately overbought condition is accounting for the lion share of the recent Financial (XLF) correction. However, it is interesting to note a positive outside reversal day has developed on 1/30/20. The ability to surge above its 50-day ma (30.40) is also a positive development. If the 10-year US Treasury yield (TNX – 1.56%) maintains above 1.43-1.51% then the stabilization in U.S. interest rates may lead to another rotation back into XLF.
Lagging Quadrant: Consumer Discretionary (XLY), Consumer Staples (XLP), Utilities (XLU), Real Estate (XLRE), Industrials (XLI), Materials (XLB), and Energy (XLE)
The bulk of the S&P 500 sectors reside in this quadrant. We recommend investors monitor these sectors closely as there is a lot of cross currents developing here.
The S&P sectors that are showing technical signs of weakening within the lagging quadrant are: XLE, XLI, and XLB.
Energy sector (XLE) has finally slipped into the lagging quadrant from the improving quadrant. The sharp sell-off in XLE began as the sector failed to breakout above key resistance in the low-60s. This led to violations of its 50-day ma (58.20) and its 200-day ma (58.17) and two large gap downs (1/21/20 and 1/27/20) as well as a negative outside day (1/29/20). However, an oversold condition is developing into this sharp drop. Key support lies along the low-50s (50-53.5) coinciding with the Dec 2018 and Aug/Oct 2019 lows. The ability to find support here may trigger a potentially sharp technical oversold rally.
Industrials sector (XLI) continue to decline further within the lagging quadrant. However, it is now testing crucial near-term support along its 50-day ma (81.97). A successful test of XLE here may signal an improvement in this group. Violation of support opens the door for a deeper correction toward major support at 77.5-79 (200-day ma and extension of the 2-year breakout).
The commodities-based Materials sector (XLB) has fallen due to a rising US Dollar as well as geopolitical news (i.e., coronavirus). A gap down on 1/30/20 warns of a key test of its 200-day ma (57.45) and May 2019 uptrend. The ability to find support here solidifies a bottom allowing for the next rally.
The S&P sectors that are improving and emerging as future S&P sector leaders include: XLU, XLRE, XLP, and XLY.
Utilities sector (XLU) has been one of the best performing S&P sectors over the past few weeks on the backdrop of geopolitical uncertainties and the decline in US interest rates. An overbought condition is developing into this rally. Key initial support rises to 64-65, and below this to 60.5-61.25.
Real Estate sector (XLRE) has also rallied sharply over the past few weeks and is trading at moderately overbought levels. A negative outside day on 1/29/20 warns of a near-term correction to key initial support at 38.5-39 (50-day ma and mid-Jan 2020 breakout).
The defensive minded Consumer Staples sector (XLP) is showing considerable relative strength in recent weeks as it closes in on the improving quadrant. XLP has recently generated a positive outside day (1/30/20) and is now threatening to breakout to new all-time highs (64.24 – 1/22/20). Initial support rises to 62-62.5 (50-day ma and Jan 2020 lows).
The economically sensitive Consumer Discretionary sector (XLY) is nearing a critical phase of its market cycle as it is currently testing its 50-day ma (124). Additional support is also visible along its recent technical breakout near 122-123. The 200-day ma continues to trend higher near 119.94. This provides major support on pullbacks. The proximity of XLY to the two key moving averages suggests a very favorable risk/reward trade developing. If this trend continues, watch for individual cyclical stocks to begin to emerge as market leaders.
Improving Quadrant: (Communication Services - XLC)
After losing the Energy sector, the Communication Services (XLC) is the only S&P sectors residing in this quadrant. XLC continues to improve and is slowly moving toward the leading quadrant. However, this sector has experienced above average volatility in recent weeks. An overbought condition hints of a consolidation. Two large gap downs on 1/27/20 and 1/30/20 confirms this near-term correction. Nonetheless, XLC has broken out of a major technical base above 51-51.5 during Nov 2019. The sharp decline in the past week or so hint of an important near-term test of support at 53.82 (50-day ma). Secondary support is also available near 50.5-51.5 (200-day ma and the prior Nov 2019 breakout).