S&P 500 Approaching Resistance, Avoid Financials, Buy Defense

|
Includes: DPST, FAS, ITA, KRE, SPY, XLF, XLK
by: Richard Marzouka

Summary

Some tricks in charting can help guide entry and exit points on the S&P 500. With weak sector leadership the market will likely fail to go higher.

Despite rising rates, financials continue to deteriorate and will likely lag until the June stress tests.

Aerospace & Defense has outperformed the Technology sector and is already making new highs.

The market correction is still playing out. I will take a brief overview of some market behavior and help point out some sectors you should avoid and what to be investing in. There is clear indecision in sector leadership and looking at some charts may help put things into perspective.

First let’s look at the S&P 500 chart. (SPY)

Are we finally digging our way out of this correction? The market has drug across the 200 day moving average and now rising back higher above the 50 day. Is it time to call the “all clear”?

There are some cheats you can use in trading that can help make some sense of which way we are headed. Let’s call this the Hi/Low cheat in market charts. If we look at the big selloff from the height to the bottom of the first drop we have a Hi and a Low point. Drawing a line between the two points, then drawing a perpendicular line half way between the points will give us a cheat line.

Now I didn’t predict when the first selloff happened, but the parabolic nature of the climb gave many professional traders pause and caution as retail inflows surged into ETFs. You can see in the chart how the cheat line could help show where selling would happen on every rebound up. I was fairly confident in a market retest and I was determined to create more cash on every peak.

Let me show you a little more insight into the chart.

Source: ThinkorSwim

The top green line is the perpendicular line drawn from the first Hi and Low. The lower green line is a parallel line running at the same angle originating from our first Low point. The blue line traced the lows higher. You can see the market was rebounding in a channel. Visualizing that channel gives clear points which highs to sell. A breach below the blue trend line sent the market into another round of selling.

So is the market going higher from here? The declining red trend line from the market high and the intersecting green parallel line from the low point suggest heavy resistance ahead. This level is around 2735-2745. It is unlikely the market will breach this level on the first attempt without strong sector leadership.

Where has the leadership gone? The two main heavyweights are financials and technology. Between the two sectors they make up roughly 40% of the S&P 500. Despite strong earnings from banks we linger.

Financials

Despite all the strong verbage of rising rates and tailwinds in financials in 2018. The chart tells another story.

Lower highs and a declining RSI can be seen. Despite strong earnings from most banks (with few exceptions) the (XLF) has not rallied. The chart on (KRE) the regional banks paints a similar picture.

The market is clearly worried about the financial sector despite the story line of rising rates equals rising financials. Clearly something is wrong here. I expected a modest rally with positive earnings from financials but the charts quickly rejected my theory. Regional banks are expecting increased competition in deposits. While an even bigger concern for financials is the flattening rate curve.

The flattening curve is at financial crisis levels not seen in 10 years. No one can say with certainty how this quantitative tightening is going to play out. The banks need to show increase profits from increase in lending before the sector can gain some ground. It’s also important to note that the financial sector struggle ahead of a stress test and tends to rally after. For the reasons laid out above, I do believe financials will trade sideways to down in this market. I would hold on XLF, KRE and their 3x ETFs (FAS) and (DPST). I do expect a better entry point into financials in June, just before the release of the stress test results.

Which sector should you have exposure?

Source: TipRanks

The iShares US Aerospace & Defense ETF (ITA) has beaten the S&P 500 in the last 12 months and has rebounded to market volatility very nicely. How has it performed against Technology?

Source: Google Finance

You can see the ITA has outpaced the technology sector ETF (NYSEARCA:XLK) and while market remains in correction this sector is making new highs.

Source: TipRanks

Conclusion

The financial sector is unlikely to gain momentum ahead of the June stress test results. This sector will likely underperform and lag the market leadership. Aerospace and Defense sector has been a strong performer and has already pulled ahead of the favored Technology sector. This sector will continue to drive higher with increase in defense spending, geopolitical uncertainty, and strong long term earnings growth. For broad exposure consider the ITA. In my next article, I will highlight a top pick in the space likely to outperform the market.

I wrote this article to show some charting tricks and concepts to help people invest and trade better.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Information reflects my opinion and interpretation of market conditions.