Weekly Chart Review
Reversal?
We have looked at the following chart for the last several weeks. The target remains 4,277 until we have reason to believe the narrative has changed.
Let’s examine that narrative for a moment as there are a few items that are raising the yellow caution flag.
First, Friday’s price action created what appears to be a “Long-Legged Doji” pattern (see inset in the chart).
Investopedia provides the following commentary for a “Long-Legged Doji”:
“The long-legged doji is a type of candlestick pattern that signals to traders a point of indecision about the future direction of a security’s price…These doji can be a sign that sentiment is changing and that a trend reversal is on the horizon.”
The trend since March 13th (the “head” of the inverse H&S pattern) has been higher. Is this Doji candle suggesting a point of exhaustion and that a reversal is near?
Second, the “Relative Strength Index” in the bottom panel of the chart is not “overbought” as of yet, but we’re definitely approaching that point. Another sign that a reversal is near?
Third, recall what I said in the Weekly Chart Review from April 3rd regarding the “gap that needs to be filled”:
“I’m a big believer that all gaps get filled. The question is always over what time frame. It could be this week or it could be two months from now, no one knows. Either way, this is a price area (red shaded box) where the S&P 500 will “need” to trade at some point in the future.”
Is the price action going to move lower to “close this gap”?
Fourth, if we zoom out and look at a weekly chart (see below), we find that we have an almost perfect symmetrical triangle that has formed.
Triangles can be either a “continuation” pattern or a “reversal” pattern. If we look at the longer-term trend, the trend since the beginning of 2022 has been lower.
Therefore, for this to be a “reversal” pattern, the price action needs to clear to the high side of the triangle. If that happens, our price target becomes 4,965.
Alternatively, for this to be a “continuation” pattern, the price action needs to clear to the low side of the triangle. If this happens, our price target becomes 3,108.
Richard Schabacker (aka the Godfather of technical analysis) made the following statement in “Technical Analysis and Stock Market Profits” with regard to triangle patterns:
“In other words, other things being equal, the Triangle denotes continuation of the previous major movement more often than it does a reversal of that preceding trend.”
It is unclear which way this triangle will resolve itself but there are enough “yellow caution flags” that lead me to believe this could be a down week for the market and we should conservatively err on the side of thinking this may be a “continuation” pattern and not a “reversal” pattern.
Let’s say I am completely wrong and this becomes a reversal pattern. From Friday’s close to our target of 4,965, there are still more than 800 points (or +20%) to the upside. My point here is that you still have time to get in.
Alternatively, if this becomes a continuation pattern and we look to our target of 3,108, that’s over 1,000 points (or -25%) to the downside. Recall, a -25% loss requires a +33% gain just to get back to where you started. Losses are always the killer.
Given where we are in the market cycle and the cautionary flags that appear to be surfacing, the prudent thing to do is to give this market a week or two to prove itself and which way it ultimately wants to go. If up, you’ve still got time to get in. If down, you will have saved yourself some heartache if you took a few chips off the table.
Sector Review
Let’s take a quick spin through a few of the sectors for the week and as always, I will be using the Heikin-Ashi weekly charts and comparing each sector to the S&P 500 (SPY).
Communication Services (XLC/SPY)
Last week I noted:
“We are quickly approaching overbought levels on a relative basis so proceed with caution.”
For the week, XLC returned +0.51% vs. a return of +0.80% for SPY.
We are now even closer to being overbought relative to SPY so I would suggest again, "proceed with caution” for XLC relative to SPY.
Energy (XLE/SPY)
Last week I noted:
“For now, we’re a long way from overbought so it’s not inconceivable to think this positive trend could continue.”
For the week, XLE returned +2.65% vs. a return of +0.80% for SPY.
While I still think the medium-term trend is higher, the last two weeks have seen returns of 2.60% and 2.65%, respectively. That is a pretty substantial two-week move. With that said, I wouldn’t be surprised to see Energy take a bit of a breather this week after two stellar back-to-back weeks.
Financial (XLF/SPY)
Last week I noted:
“Can we go lower on a relative basis, sure, but when it turns, it has the potential to be a fairly prolonged move higher so it might be worth dipping a toe in the water.”
For the week, XLF returned +2.78% vs. a return of +0.80% for SPY.
Given how oversold XLF is relative to SPY, I think this move higher could be just getting started.
Industrial (XLI/SPY)
Last week I noted:
“XLI is not oversold relative to SPY and we have not reached our double-top prescribed target; therefore, we should expect more of the same.”
For the week, XLI returned +2.11% vs. a return of +0.80% for SPY.
Last week I was calling for XLI to continue to move lower relative to SPY. I got this one completely wrong. With that said, the downtrend remains intact, we haven’t reached our double-top prescribed target and we’re not oversold. Add it all up, and I continue to believe XLI should move lower relative to SPY.
Real Estate (XLRE/SPY)
Last week I noted:
“While not the performance I would have hoped for on a relative basis, note that a) the Heikin Ashi candle has moved up from last week and b) the RSI (bottom panel) is beginning to tick up. These are signs that the bottom may be in for XLRE relative to SPY.”
For the week, XLRE returned -1.35% vs. a return of +0.80% for SPY.
This is the classic case of deeply oversold getting even more deeply oversold. Similar to my comments concerning the Financial sector from last week “It may be worth dipping a toe in the water”.
Technology (XLK/SPY)
Last week I noted:
“This would suggest XLK could continue to move lower relative to SPY.
Watch the blue trend line. We have not broken through this line in months. Will it hold? If so, the damage will be contained. If not, December 2021 is your proxy for what can happen.”
For the week, XLK returned -0.28% vs. a return of +0.80% for SPY.
Note the perfect tag of the blue line as I suggested last week. Also, note that the RSI is rolling over from overbought conditions. I think this will be an interesting week for XLK vs. SPY. Do we hold the blue line or break down and through it? If the latter, this thing could have a ways to go. Proceed with caution on XLK in the short term.
Summary
If there is one thing that I have come to love about the markets over my 20+ year career, it’s that there’s never a dull moment. There is always some storyline playing out and some narrative to try and decipher.
I always try to take emotion out of the analysis and simply look at what the market is telling us. No one ever gets it right all of the time but hopefully, by keeping the conversation going, we can collectively get it right more times than we get it wrong.
Until next week…