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Technology continues to lead the overall market and outperforms other major averages.  The Nasdaq Composite is stronger than the S&P 500 Index, a condition that has characterized more favorable overall market climates historically.  In May, we saw the first noteworthy selling that generated the most fear and angst seen in many months among investors (including me).  But the decline was short-lived as stocks have rebounded.  Broad market indexes are resilient as price trends remain intact.  Our models remain overall neutral-positive.

But we are not in the clear.  Leadership has been thin.  Stocks making new 52 week highs on the New York Stock Exchange index have been rather lackluster.   The bellwether Financials Sector SPDR (XLF) was a hot sector early in the year.  However, in recent weeks financials are lagging, not a good sign for the bulls.

The momentum of the rally has been diminishing over time and warning signals are starting to appear.  As discussed below small-caps remain in their 16-month old price uptrend that began (on monthly charts) in February, 2016.  However, the relative strength trend of small caps outperforming large caps that also started in February 2016 has now been broken.  In general, when financials and small caps are weak, this is not a sign of a healthy market.

So the question remains: will the major averages will break out to new highs and begin another leg up, or will the major averages stall, turn lower and usher in a more meaningful decline?

11 Clues You Want To Watch For a Potential Trend Change

  1. Whether overseas markets continue to rise or begin to stall and work their way lower. Watch Emerging Markets (EEM), China (FXI) and Europe (IEV) as benchmarks.
  2. Look at the Technology sector if it continues to make new highs or suddenly turn down. Monitor Nasdaq 100 (QQQ) and the Semiconductors HOLDR (SMH).
  3. The Value Line Geometric Composite, an unweighted average of roughly 1700 U.S. stocks regains strength to take out its high at 526.83 on 04/26/17. This would indicate more broad participation rather than only a few stocks rising.
  4. Observe the action in the Biotechnology sector (XBI). Strength would indicate investors are willing to take on more risk.
  5. The Transportation Average (IYT) has been weak, well below its high on 03/01/17 at 173.88. If the IYT continues to decline this would suggest a strong rally from here is unlikely.
  6. The Financial Sector regains relative strength vs. the S&P 500 (SPY). Watch XLF and KRE as benchmarks.
  7. High Yield Bonds remain firm instead of weakening and turning lower. Use HYG or JNK as a benchmark.
  8. Apple continues to be a leader (APPL). Upside objective 175.00.  A break below 150.00 on a closing basis could portray weakness to follow in other technology stocks.
  9. Volatility remains low. Look out if VIX takes out the previous high from 05/18/17 at 16.30.
  10. New 52 week lows on the New York Stock Exchange Index remain low, presently at 33. An increase to over 150 would not be a good sign.
  11. Watch the last hour of trading. If the major indices closed near the highs of their daily range consistently this would be bullish.  If the major average closed near the low end of their daily range consistently this would be bearish.

Warning:  A potential trend change has been given by Russell 2000 (IWM).

Russell 2000 Index (IWM) ETF Weekly Top and (IWM) Russell 2000 Index / (SPY) S&P 500) Ratio (Bottom)

 

The top portion of the chart shows the weekly iShares Russell 2000 Index ETF (IWM) which is made up of companies with a market capitalization of between $300 million and $2 billion.  After the election last November, small caps lead the advance.
Strong gains followed in January and February this year peaking on 04/26/17 at 141.81.  The IWM has been unable to generate enough momentum to break out and regain the strength it had early in the year because investors have favored large-cap growth stocks.

The Russell 2000 (IWM) has been in an uptrend since 02/01/16. The intermediate uptrend will remain intact as long as the IWM is above 130.00.   If the intermediate trend is violated, this would not be a good sign and the likelihood of a potential serious decline would increase.

The bottom part of the chart is the Weekly Russell 2000 /S&P 500 (IWM/SPY ratio).  A rising line means the IWM is stronger, and if falling, the S&P 500 is stronger.  The IWM ratio was steadily rising with a few small turn downs but holding above the uptrend line (purple line).  However, the uptrend from 02/01/16 has been broken.

Summing Up:

A warning of a potential trend change has just been given. I recommend reviewing your portfolio to make sure you are not overly exposed to small caps.  Historically, when IWM is stronger than the S&P 500 (SPY) it has been a bullish condition for the broad market. This condition is no longer supporting the market. Risk has increased.  For those of you who have large holdings, I suggest shifting your assets out of small caps and move into S&P 500 (SPY) or raise cash and wait for a safer buying opportunity later this year.  If the IWM fails to take out its high and turns down below support at 130.00, you can expect further weakness in IWM and could potentially spread into other sectors of the market.

I would love to hear from you. Please call me at 516-829-6444 or email at bgortler@signalert.com to share your thoughts or ask me any questions you might have.

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*******Article published by Bonnie Gortler in Systems and Forecasts May 25, 2017

 


Disclaimer: Although the information is made with a sincere effort for accuracy, it is not guaranteed that the information provided is a statement of fact. Nor can we guarantee the results of following any of the recommendations made herein. Readers are encouraged to meet with their own advisors to consider the suitability of investments for their own particular situations and for determination of their own risk levels. Past performance does not guarantee any future results.

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The S&P 500 (SPY) has been moving mostly sideways for three months, a few percent up or down, in a trading range. The next earning season is starting the second week in April, which will likely increase market volatility. However, our models suggest a major correction is not going to happen now. One could be possible later in the year. What could cause a significant market correction? When will buying on the dips be a losing strategy? Will the threat of an interest rate hike over the market be the catalyst for heavy selling? So far this is not the case. Is the market going to pull back and break the recent lows of 3/26/15 or rally toward the highs and break through them with another leg up? The jury is still out, but I believe that the biotechnology sector will tip us off before a significant decline gets underway.

What Are The Charts Saying?

Biotechnology (XBI) has been a powerhouse, leading the stock market higher. The easy money could be over. With momentum clearly weakening, risk is increasing. Biotechnology has now joined the Nasdaq 100 Index (QQQ, see the 03/20/15 newsletter) in showing chart patterns that give a warning of a possible decline ahead and increasing risk.

SPDR S&P Biotech ETF (XBI) Weekly Price and Trend Channels (top), and 14 week RSI (bottom)

033015 xbi price rsiThe top part of the chart to the right is the SPDR S&P Biotech ETF (XBI). The assets that comprise the top 10 holdings as of 03/27/ 15 are 12.01%. Even though this is a very volatile ETF, its holdings are well diversified, with the largest (Prothena Corp PLC, PRTA) representing only 1.40%. This index is made up of the biotechnology sub-industry portion of the S&P Total Markets Index that tracks all the U.S. common stocks listed on the NYSE, AMEX, NASDAQ® National Market and NASDAQ Small Cap exchanges.

Notice the XBI made a low in October 2014 at 141.85, followed by a very impressive rise to 244.98 peaking on 03/20/15, a rise of 72.70%. Biotechnology is highly volatile compared to the S&P 500 as you can see by the large gains and the quick reversal of 15% within a week. The XBI penetrated the weekly channel on March 20, suggesting that its rally would continue. Instead, XBI reversed sharply falling to 207.75, stopping at the up trendline from October’s low, an important area to hold. Biotechnology has since stabilized off of its lows. A break below 207.75 would break the uptrend.

The lower portion of the chart is the Relative Strength Index (RSI), a technical momentum oscillator that, like MACD, helps you identify overbought and oversold conditions and can be used by traders to buy weakness and sell strength. When RSI is 70 or above it’s considered overbought, and if the RSI hits 30, it’s oversold.

In a very strong trended market RSI can get to 80 before prices tend to stall. In a very weak market 20 is hit before the market finally bottoms. I like to use RSI to spot potential turns and trend changes after a large rise or fall or when a trendline is broken like what just occurred in the XBI index.

The uptrend from April 2014 has not been violated, but notice the uptrend in RSI from October 2104 has been broken to the downside. This leads me to expect further weakness in XBI to take out the recent low of 207.75 and possibly test the lower channel of 200.00. This is a warning that now is a time to be cautious about taking new investments and take some profits. You don’t want to be caught in biotechnology if the bullish trend changes. The uptrend from April 2014 has not been violated. Support is at 200.00, a break below would suggest prices could fall to 165.00.

Weekly XBI/SPY ratio (top) and RSI of the XBI/SPY ratio (bottom)

033015 rsi xbi spy weeklyIt appears that investors are moving away from the riskier areas of the stock market. The top portion of the chart shows that relative strength shifting from the Biotechnology sector (XBI) to favoring the S&P 500 (SPY). A turn down in the relative strength ratio of XBI/SPY has taken place but so far the price uptrend from October 2014 remains in effect. If the trend line is violated expect XBI to fall faster than the S&P 500. The RSI of the XBI/SPY Ratio (lower part) is worth watching. The trendline is intact but further weakness would confirm the possibility that the high in XBI/SPY has been made and that the overall leadership has changed to favor SPY over XBI for the intermediate term, suggesting slower gains not only for biotechnology, but also for technology and higher risk sectors.

Just To Sum Up.

Our models continue to be favorable for the intermediate term suggesting below average risk for a serious correction, but the chart patterns are showing investors moving out of biotechnology, joining technology which is also losing relative strength to the S&P 500. The uptrend in RSI from October 2104 has been broken to the downside so I am expecting further weakness in XBI to take out the recent low of 207.75 and possibly test the lower channel of 200.00. If you are invested in biotechnology, this would be a good time to reduce holdings, take profits and rotate into a new sector with less risk.

Would you like to be more prepared if the stock market trend changes from bullish to bearish?

Let’s talk, I invite you to contact me and share your challenges. Call me at 1-844-829-6229 or Email me at bgortler@signalert.com with your observations.

 

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