Stock Market Review, Sentiment Analysis And Sector Map

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Includes: SPY, VXX, XLB, XLE, XLF, XLI, XLK, XLP, XLU, XLV, XLY
by: Mitch Bulajic
Summary

Three times in four months the SPY failed to penetrate the 280-resistance level, and heading there for the fourth time with one bullish and one bearish scenario in play.

Put Call ratios turn bearish, VIX and the VIX ETF VXX are still bullish but approaching extreme supports, while the money flows (institutional and speculative) are continuously weak.

Sector rotation distorted and sporadic, while small cap and value still the game in town.

Small cap Energy, Materials and Health Care is where you want to be.

Stock Market Review

Three times in four months the SPY failed to penetrate the 280-resistance level, and heading there for the fourth time, making the 280-resistance level (also the Fibonacci resistance) the key milestone for the bull market to watch.

I mentioned the importance of this resistance level in an article I wrote for Seeking Alpha on June 6th “Weekly Stock Market Price and Sentiment Color”:

Everybody is talking about the obvious resistance at the 286 high from January 29th, but to be ahead of the curve the 78.6% retracement level at 280 is a first and more important resistance, because it exactly corresponds to the resistance reached twice on February 27th and March 13th. If this resistance is broken and accompanied by high volume and improving money-flows, the 286-high resistance becomes less important and most likely soon thereafter broken.

The current rally is a short-term phenomenon on the heels of the Friday jobs report, but looking at the big picture, we will be for some time in a range market until a clear reversal or consolidation chart pattern develops in conjunction with accelerating and consistent money flows.

The next attempt for the market to penetrate the 280-resistance level is the key to watch, not just because this is the fourth attempt, but because the last attempt was accompanied by strong institutional money flows that fizzled out within days (purple line, chart below). We believe that the next battle for the 280-resistance can have two extreme outcomes and no middle ground:

  • Failure to break the 280-resistance will also result in breaking the recent bullish trendline, where both events would lead to accelerating money outflows and fast run on the 267-support level and development of a reversal bearish price pattern.
  • Success in penetrating the 280-resistance level will make this important resistance level and even more important support level as base of the next leg of the bull market with price target at 306-resistance.

Which scenario will prevail will be in large dependent on the money flows. Right now, both money flows are consistently weak - the speculative money flows (blue line below) also known to be the short term and turnaround indicator, and the institutional money flows (purple line below) also known as the long term and trend indicator,

Courtesy of TD Ameritrade ThinkorSwim

Sentiment Analysis

Equity put-call ratios (standard and weighted) are on sell signals now. The weighted ratio has been on a sell signal for weeks, while the standard ratio turned to a sell signal last week. Both signals are coming from relatively low points on their charts, meaning that if a significant and consistent sell reversal materializes, it will result in a very strong sell signal. Both ratios were lower in December and January, which is a rare instance, however it did not result in a sell signal.

Courtesy of The Options Strategist

Volatility is somewhat bullish for stocks – mostly because it is falling from the recent highs to below the psychological 15-support line on the VIX or 35-support line on the VXX that has been consistently bullish for stocks since April.

The construct of volatility derivatives is bullish now. The VIX futures are trading at a premium to VIX, and the term structures slope upward. Those term structure slopes are not particularly steep, while the term structure of the CBOE Volatility Indices is a bit steeper, and thus bullish as well. Overall for the more consistent and lasting bull market, the VIX will need to settle under the 15-resistance level – this is the key to watch.

The Larry McMillan’s day-weighted average between the first and second month futures contracts (chart below) measures the premium amount that futures currently trade above or below the cash VIX, (contango or backwardation) until front month future converges with the VIX at expiration. At the extremes, declines below 10 and advances above 30 are both unstable. Right now, we are in the middle of the range, indicating that the current regime and trend is at no danger.

Courtesy of CBOE or iVolatility

Sector Map

The sector rotation has been influenced by interest rate projections, business cycle maturity - and recently abruptly dominated by the trade war tensions. While there is a bias, but by no means consensus, that we are in a rising interest rate environment and at the end of the business expansion cycle, the trade war tensions and uncertainty have caused extreme cross sector volatility and are the main culprit of the recent sell-off.

The main and ongoing market theme is the rotation into value stocks and particularly small cap stocks - making the small cap value stocks the absolute winners. This trend is still on, given the continued strong momentum and money flows.

The sectors story across the board can be categorized in three range-confined groups with overall no significant theme or trend in sector rotation:

Below is the technical, fundamental and money flow evaluation and score card table for the major Indexes and Sector ETFs.

Sector Specific Stock Picks

The stocks we particularly like are found in the intersection of small cap sector with Health Care, Energy, and Basic Materials sectors. Below we have shortlisted the following stocks with bullish price patterns and rising money flows that will most likely outperform within the mid-term to long-term cycle time frames.

Conclusion

If you had to just look out for few things in the market until month-end, it would be the 280-resistance on the SPY, 15-resistance on the VIX or 35-resistance on the VXX, and confirmation of the put call ratio sell signals. And of course, the earnings season that will most likely by end of the month give us clearer patterns and trends in sector rotation.

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.