Worship at the Church of What’s Working Now
Energy, technology, and financials still lead while staples, health care, and utilities lag. What to do now?.
By Michael Kahn
Wall Street wisdom suggests investors should worship at the Church of What’s Working Now. That means that despite what we think should happen, we need to restrict our activities to what is actually working. For investors, that means sectors in the stock market — such as financials — that are actually gaining ground.
The broad stock market is basically a mathematical mash-up of each sector, and each sector, in turn, is a mash-up of its components. That means, of course, that it’s possible to have parts of the market moving higher and parts moving lower, even though the major averages seem to be stuck in the mud.
I’ve touched on this topic several times recently, but there is one chart that really drives this idea home. A performance chart of the top and bottom sectors versus the Standard & Poor’s 500 index for the past three months makes it clear (see Chart 1).
That said, I blew it last week when I panned banks due to several technical failures on the charts.
Stocks in that group reversed course within days and several ran to new highs, effectively negating any bearish signals I saw at the time.
Putting aside what the charts had suggested, the question is what should we do about it now, if anything?
I am a little leery of making any big commitments to the market before the election. But for those who are a bit more adventurous, the idea is to allocate more money to winning sectors and less to losers.
As usual, I start with the broad market, and for that I like to look at the New York Stock Exchange Composite index. Although not perfect, I think it represents the “average” stock better than the S&P 500. It is true that the latter covers the lion’s share of market value, but the NYSE index gives a voice to smaller stocks as well.
The NYSE Composite is currently in a sideways pattern, with a bearish leaning. It also eased its way through its rising 2016 trendline, which is arguably a break in the trend (see Chart 2). I say “arguably” because a technical break really is supposed to happen on vertical movement — price — and not horizontal movement — time.
To be sure, the S&P 500 itself is now hugging its own 2016 trendline, and a breakdown, if it occurs, would suggest a new declining trend has begun. The same is true for the NYSE, as both indexes are poised for nontrivial price moves.
The timing on the charts as technical support and resistance features converge seems to coincide with Election Day. It is not a surprise that the market is floundering now ahead of that historic decision.
With the market flat to lower, sectors need only be flat to higher to officially outperform. Indeed, the Technology Select Sector SPDR exchange-traded fund (ticker: XLK) is edging higher at a slow pace.
Big components, such as Facebook (FB), continue to pull the weight.
However, even though the Energy Select Sector SPDR ETF (XLE) is beating the market for the past three months, it seems to have stalled (see Chart 3). Of course, it is possible to beat the market by losing less instead of actually making money.
That leaves the financials, and specifically the banks, which are beating the market and moving through resistance to new highs. How can they be the third-best performer over the past three months yet be in the best position now? The answer depends on the exact date the comparisons began. This is why we need to combine statistics with chart reading to get the best result.
For those so inclined, we can flip the analysis upside down to find sectors ripe for more selling. The three lagging groups would be the places to look for the weakest stocks to either trim from portfolios or sell short.
Even if investors take no action now, these groups provide the best places to find stocks to sell should the market break to the downside.
Until we get clarity on market direction, it makes sense for investors to move some money from losing to winning sectors. My advice? Sit on the sidelines and watch as the next two weeks play out.