3 Sizzling Summer Sectors

07/20/2011 10:45 am EST

Focus: ETFS

Thomas Aspray

, Professional Trader & Analyst

Strong market performance this week has set up favorable risk/reward buying opportunities in top-performing sector ETFs tracking consumer discretionary, technology, and consumer staples.

The impressive rally on Tuesday rescued the stock market from critical support, as the financial-heavy Spyder Trust (SPY) dropped below the 61.8% support on Monday, but closed well off the lows. The Dow Industrials retraced just over 50% of the prior rally while the tech-heavy PowerShares QQQ Trust (QQQ) held its 38.2% retracement support.

The Advance/Decline (A/D) lines for all of the major averages have turned up sharply, but it will be important that they keep pace with prices and confirm any upside breakouts. The McClellan Oscillator has turned up from oversold levels, and at -42, it is well below overbought territory.

The decline into the June lows and the rally into the early-July highs have caused some significant changes in the relative performance, or RS analysis, for the major sectors. Since mid-April, my sector analysis has favored consumer staples and health care as the “new star performers.” 

Though these two sectors still look positive technically, they are not currently leading the market higher like they did going into the May highs. In June, I added the Select Sector SPDR – Utilities (XLU) to my favored list as well. (See “The Best Sectors for Summer.”)

Last month, I also added the Select Sector SPDR – Consumer Discretionary (XLY), which alongside the Select Sector SPDR – Technology (XLK) makes up the leading sector ETFs.

chart
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Chart Analysis: The Select Sector SPDR – Consumer Discretionary (XLY) moved through its downtrend, line a, in late June, rallying to a high of $41.78. XLY held the 50% support level on Monday with a low of $39.63.

  • There is next resistance at $41 with the 127.2% retracement target at $42.30
  • The daily relative performance, or RS line, moved through resistance, line b, in June, confirming that the fund was outperforming the S&P 500. It also shows a strong uptrend, line c
  • The on-balance volume (OBV) confirmed the July high and has now turned up from its rising weighted moving average (WMA)
  • The weekly OBV (not shown) is positive and also made new highs in July

The rally in the Select Sector SPDR – Technology (XLK) from the June lows was impressive, as the fund gained 9.5% versus a 7.5% gain for the Spyder Trust (SPY). Though the difference may not seem too dramatic, XLK outperformed SPY by 2% in just nine days.

  • XLK held the 50% support at $25.54 on Monday and has stronger support in the $25 area
  • The RS line moved through its downtrend (line f) on July 6 and shows a strong uptrend on the daily chart, line g
  • Weekly RS (not shown) is rising sharply but has not yet broken its downtrend
  • The daily OBV retested its breakout level, line h, and has now turned higher
  • The daily chart shows strong resistance, line d, in the $26.88-$27 area. A close above this resistance will complete the trading range (lines d and e) with upside targets at $29.50-$30

NEXT: See Latest Price Action for Health Care and Consumer Staples

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chart
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The daily chart of the Select Sector SPDR – Health Care (XLV) shows a classic continuation pattern, lines a and b. The 38.2% support level held on a closing basis in June with the low at $34.54.

  • This is one of my favorite chart patterns, as it allows for very good risk control. The upside projections from the flag formation are at $37.40-$37.90
  • The RS line is still in a short-term downtrend and has formed lower lows over the past two months. This indicates that XLV is currently acting weaker than the S&P 500. Long-term RS support is at line c
  • The OBV is below its weighted moving average and the downtrend, line d. The weekly OBV is also still below its weighted moving average.

The Select Sector SPDR – Consumer Staples (XLP) has also formed a continuation pattern, as the 50% support level at $30.58 and the former resistance (line f) was tested in June.

  • A close above the early-July highs at $31.92 will indicate a move to the 127.2% retracement resistance target at $33
  • The continuation pattern has upside targets at $33.90
  • The RS tested its uptrend from the February lows, line g, in June. A drop below that level would be negative. The weekly RS is also at a critical juncture
  • The daily OBV dropped sharply from the May highs and is now testing its downtrend. A breakout looks likely. The weekly OBV (not shown) did confirm the May highs
  • Short-term support is now at Monday’s low just below $31 with stronger support at $30.58

What It Means: The stock market now looks ready to test the early-July highs, and if the A/D numbers are strong the rest of the week, the May highs could also be exceeded.

My analysis of the Select Sector SPDR – Utilities (XLU) is still positive and the chart (not shown) looks very similar to those of XLV and XLP. Though I still favor holding long positions in all three of these ETFs, it does look as though the consumer discretionary and technology sectors will perform the best.

The daily analysis of Select Sector SPDR – Energy (XLE) is positive, but the negative weekly divergences have not yet been resolved.

How to Profit: My previously recommended buying level in the Select Sector SPDR – Consumer Discretionary (XLY) at $38.66 was not hit. I would now go long at $40.54 with a stop at $39.27 (risk of approx. 3.2%).

For the Select Sector SPDR – Technology (XLK), go long at $26.34 with a stop at $25.44 (risk of approx. 3.4%).

For the Select Sector SPDR – Consumer Staples (XLP), buy at $31.42 with a stop at $30.74 (risk of approx. 2.2%). Sell half that position at $32.44 and raise the stop on the remaining position to $31.22.

Portfolio Update (See each of the prior recommendations here.)

Select Sector SPDR – Health Care (XLV): Buyers should be 50% long at $35.14 and 50% long at $34.96. Raise the stop from $33.92 to $34.42, sell half the position at $36.32, and raise the stop on the remaining position to $35.12.

Select Sector SPDR – Consumer Staples (XLP): Buyers should be 50% long at $31.12 and 50% long at $30.96. Raise the stop from $30.54 to $30.74, sell half the position at $32.44, and raise the stop on the remaining position to $31.22.

Select Sector SPDR – Utilities (XLU): Buyers should be 50% long at $33.16 and 50% long at $32.86 with a stop at $31.88. Raise the stop on that position to $32.74, sell half at $34.18, and raise the stop on the remaining position to $33.34.

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