From the desk of Tom Bruni @BruniCharting
Tuesday’s Mystery Chart had a lot of people talking and guessing (incorrectly, as usual), so thank you all for your feedback and participation.
Opinions were mixed on how to approach it, but I’d say the majority are looking to position themselves for further upside.
With that as our backdrop, let’s get into it.
The chart in question is the Dow Jones Auto Index/Consumer Discretionary Sector (DSAU/XLY) ratio, and for now, this bullish divergence and failed breakdown is intact and suggests further mean reversion in the weeks and months ahead.
Click on chart to enlarge view.
The conditions that sparked us writing this post are not unlike what encouraged us to look into Chinese Internet stocks. At the index level, something appears to be changing, so we took a look under the surface to see what’s going on.
So what did we find? Within both indexes, there are a lot of messy charts, many of which have been beaten down and are now looking to work their way higher after meeting downside objectives and/or building a base.
What it really comes down to is that there are a lot fewer stocks that we’d like to be selling today than there were earlier this year. With that said, there are still very few clean setups. Just because I think the bias is higher in many of these stocks doesn’t mean we need to trade them.
With that said, let’s get into the stocks that are showing relative strength and will likely lead should this move at the index level persist.
Here’s Fiat Chrysler Automobiles NV (FCAU) breaking out of an 18-month downtrend after basing at the 61.8% retracement of its 2016-2018 rally. With prices breaking out and momentum getting firmly back into overbought territory, this looks like the end of the stock’s correction and beginning of its move back towards all-time highs.
Harley-Davidson (HOG) has been a disaster since early 2017, but after a failed breakdown and bullish divergence sparked a sharp rally in September, we are now seeing prices break above a 3-year downtrend line. Could this be a potential breakaway gap? Sure. Either way, the point stands that I’d much rather be buying this chart than selling it at current levels.
Ferrari N.V. (RACE) just made new all-time highs last week, but quickly failed. After some backing and filling in the near-term, this stock could get back above 171 and move towards its next price objective near 185.
Last, but not least, is Toyota Motor Corp. (TM) which reports earnings today (November 7th, 2019). While we don’t want to step in front of event risk, if prices can end the week above 140 that would confirm a breakout from a 12-year base and beginning of an uptrend that targets 190 long-term.
One risk to this thesis is the weakening of the Consumer Discretionary sector as a whole relative to the broader market. Buying a weak sub-sector in a weakening sector is not exactly the approach we typically take, so that’s why our preferred vehicle to express this thesis is Toyota Motors which is showing relative strength and positive momentum. That way if we’re wrong we limit our risk by being in a stock that’s acting the best from a technical perspective.
Conclusion: Overall we think the reward/risk on the short side of this sector is no longer attractive on an absolute or relative basis, so we’re looking for opportunities to take advantage of its improving price action.
Toyota remains the cleanest setup in our eyes and we would be buying that breakout once prices print a weekly close above 140.
Thanks for reading and please let us know if you have any questions!