Acknowledging Potential Caution Flags

JC Parets
July 30, 2018

From the desk of Tom Bruni @BruniCharting

When I thought of the title for this post I was hoping to make a Nascar analogy, but quickly realized I don't know anything about Nascar or racing. With that aside, what's clear from our recent blog posts is that we remain bullish on US Equities but open-minded to the new data we're getting each day. As I was going through my sector chartbook this weekend I identified a few momentum divergences that have emerged, as well as some bullish data points that potentially offset them, so this post will quickly go through my findings and key takeaways.

I want to keep this post pretty simple in that I'm first looking at the bearish momentum divergences that have formed in some of the leading sectors of the market. These divergences and failed breakouts can signal that a correction, either through price or time, is required in the short-term.

First up is the Nasdaq 100 ETF $QQQ which is on the verge of breaking back below its June highs.

The Dow Jones Internet ETF $FDN is already back below its June highs.

The Cyber-Security ETF $HACK also failed to make a new high.

The Software ETF $IGV is threatening to break back below its June highs.

Biotech ETF $XBI is also below the June highs, settling back into its large year-to-date range.

Medical Devices ETF $IHI has been an absolute beast, but was not spared of a bearish momentum divergence and is also testing its June highs.

Consumer Discretionary ETF $XLY is back below its June highs.

Within Consumer Discretionary, Retail $XRT is consolidating through time rather than price. Resolving its range lower instead of continuing higher would have bearish implications.

What we've established is there are some bearish divergences that suggest a pause in these long-term uptrends is required in the short-term. While these sectors are still very much in structural uptrends, from a tactical perspective it still leaves the question of what areas of the market will pick up the slack if/when these leaders take a rest. It's also worth noting that if prices get back above the former highs then the bearish implications discussed above are no longer valid since, at the end of the day, this indicator is a supplemental tool and needs to be confirmed by price action.

The broad-based Financial Sector ETF $XLF is starting to see some rotation into it as it approaches 6-week highs. Further strength could indicate the continuation of its long-term uptrend.

Within Financials, Broker Dealers & Exchanges $IAI have been consolidating through time and would likely lead if the sector moves higher.

The Industrial Sector ETF $XLI looks similar in that it's been consolidating for the majority of the year, but is now hitting 6-week highs.

Within Industrials is the Aerospace & Defense ETF $ITA which has been consolidating just below all-time highs for the majority of the year.

The Healthcare ETF $XLV is also making 6-month highs.

Energy has been a mixed space, but the Refiners ETF $CRACK continues to be a bright spot as it makes new all-time highs.

The Railroad Sector continues to show relative strength and is making new all-time highs after several months of consolidation.

Last but not least is the Dow Jones US Trucking Index which has corrected through time for most of this year and should resolve to the upside.

The Basic Materials sector, along with its components like Chemical and Agribusiness Stocks are also improving after consolidating for most of the year, but their flat 200-day moving averages have kept them off the list.

The Bottom Line: While the structural trend in the US Equities market and many of the leading sectors discussed above is higher, the bearish momentum divergences and failed breakouts we're seeing suggest a short-term pause, either through price or time, is necessary. Under the surface we've seen some rotation into Financials, Industrials, and other sectors that have been consolidating which suggests they may pick up some of the slack if/when we see the current market leaders correct.

We're remaining open-minded about our bull thesis, but acknowledge that tactical shifts like the ones we're seeing above are important to recognize and incorporate into our approach to the market. Whether these developments resolve themselves through a correction or by prices and momentum getting back above their former highs, what happens from here will provide us valuable information about the overall strength or weakness of these sectors and indexes. We'll only know whether these short-term changes mark the start of a major market turn in hindsight, so for now we'll be looking to take advantage of this potential weakness to buy leading stocks at lower prices.

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Thanks for reading and let us know if you have any questions!

Allstarcharts Team

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