A Bottom-Up Look At The Stock Market

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Includes: DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FWDD, HUSV, IVV, IWL, IWM, JHML, JKD, OTPIX, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWM, RYARX, RYRSX, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, UWM, VFINX, VOO, VTWO, VV
by: Clif Droke

Summary

Weakness continues to plague most major sectors.

Utilities and consumer staples show some promise, however.

Overall U.S. market remains vulnerable to emerging markets' weakness.

Although the U.S. broad market held has up relatively well in the face of a weak emerging markets outlook, the stock market isn’t out of the woods yet and still faces significant near-term headwinds. In today’s commentary, we’ll examine the market’s biggest trouble spots, as well as two areas of impressive relative strength.

Sometimes it helps to get an overview of the broad market from the bottom up, rather than starting from the top down. The best way to do this is to examine the charts of the biggest companies across several major industries. This provides us with a good idea as to whether accumulation (buying) or distribution (selling) pressures are more apt to dominate.

Over the weekend, I took a long look at the individual stock charts of several leading groups, including the retailers, utilities, consumer staples, and banks. My overall assessment is that there is still a fair amount of overhead supply/resistance across most sectors, and this is likely to keep the major averages range-bound for a while longer. It’s still my expectation that while we should see new highs in the S&P 500 and other major indices later this summer, the next few weeks could witness a period of rest and consolidation – and perhaps even a pullback – before the market continues its upward path.

Let’s begin with the market segment that has shown the most weakness. For most of 2018, the consumer staples have conspicuously underperformed the S&P 500 and are currently not far above their lows for the year. Shown here is the Consumer Staples Select Sector SPDR ETF (XLP), which is well below its January peak. The consumer staples are also one of the few sectors that have established lower highs and lows over the last several months.

However, despite undergoing some serious selling pressure in the February-May period, XLP is trying to establish an intermediate-term bottom as can be seen in the chart below. A breakout above the $52.00 level in the XLP chart would suggest that investors are rotating into this sector, which in turn would make the consumer staples an ideal buy candidate for the next phase of the bull market once the latest soft patch has ended.

Consumer Staples Select Sector SPDR ETF

Source: BigCharts

Another under-performing segment of the market is the financial sector. I recently drew attention to this as we looked at three major areas of the financial sector, namely bank, broker/dealer, and insurance stocks. The weakest of the three areas is the banks with the broker/dealers not far behind.

As can be seen in the chart of the Financial Select Sector SPDR ETF (XLF), there’s still a lot of congestion/supply within the sector and this needs to be absorbed before the financial stocks are ready to rally again. The lower low recently made by XLF, below, is a bit troubling from a short-term perspective, as it undermines the broad market outlook and creates vulnerability for the major averages as previously discussed.

Financial Select Sector SPDR ETF

Source: BigCharts

The area that has been the most disappointing from a short-term perspective is the retail stocks. The retailers had in recent weeks shown a large measure of immunity from the internal selling pressure, which has affected other areas of the market. Now, though, it appears the internal momentum for the retail sector is getting weaker. Shown here is the latest graph of the SPDR S&P Retail ETF (XRT) in relation to its 15-day moving average.

The 12-day price momentum indicator for XRT is visible in the lower portion of the chart. The retailers still look good on an intermediate-term basis and will likely recover from the latest setback based on the strength of the buyback trend among several major retail stocks, not to mention the improved outlook for consumer spending. I consider the latest pullback in XRT to be merely a temporary pause of the much bigger upward trend in the retail sector.

SPDR S&P Retail ETF

Source: BigCharts

The sector that is showing the most strength right now is the utilities. This isn’t surprising given that utility stocks have long been standbys for when investors become defensive on the overall broad market. The Utilities Select Sector SPDR ETF (XLU) is virtually alone among the sector ETFs in having established a series of higher highs and lows in contrast to other sectors. The leading utility stocks are also sporting attractive dividend yields and should continue to benefit from the tariff scare, as investors are turning to this sector as a safe haven during the latest turmoil.

Utilities Select Sector SPDR ETF

Source: BigCharts

Despite the relative strength still present in the utilities sector, there is still an alarming amount of internal weakness visible in the NYSE by means of the daily new 52-week highs and lows. For the last six trading sessions, the new lows have outnumbered new highs by a significant margin. There were 107 new lows on Monday versus only 45 new highs – a disturbingly negative hi-lo differential on a day when U.S. equities held their own against the overseas selling pressure.

What this suggests is that internal weakness is still present in the U.S. stock market and could present a problem in the near term, especially if investors are greeted by bad news headlines. Caution is still very much the watchword for now until the new highs-new lows differential returns to normal.

Meanwhile, internal momentum for the NYSE broad market is still quite weak and definitely in need of improvement. Here’s what the NYSE short-term directional (blue line) and momentum bias (red line) indicators look like right now. The former indicator measures the 4-week rate of change in the NYSE new 52-week highs and lows, while the latter measures the 6-week rate of change in the highs-lows. The sustained decline in these indicators is telling us that the near-term path of least resistance for equities is down, which means stocks are still vulnerable to bad news.

Source: WSJ

In light of the above considerations, I recommend that investors maintain a defensive position and refrain from making any new commitments among individual stocks. Investors should also take advantage of the current environment to prune their portfolios by trimming losses among underperforming large cap stocks, raising stops on all long positions, and taking some profits on winners.

Disclosure: I am/we are long XLK, IYR.

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.