5 Top Sectors for Year End

10/07/2011 10:08 am EST

Focus: ETFS

Thomas Aspray

, Professional Trader & Analyst

After the rough last quarter, a sustained rally looks more likely, and if we get one, these are the sectors likely to lead the charge.

The third quarter ended last week. Only one sector was higher in that period, while just three of the major sectors are higher for the year.

Of course, if you are a stock investor, it is more important to compare the sector’s performance to a major average such as the S&P 500.

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The Select Sector SPDR Utilities (XLU) is still clearly the star performer, as through September 30, XLU is up 6.1% for year while the S&P 500 is down 7.4%. In fact, as the table above indicates, there are five sectors that show better relative performance than the S&P 500.

Using relative performance, or RS analysis, one can better identify how a sector is trending versus a major index like the S&P 500. By looking at both the weekly and daily data, you can get a better idea of the intermediate- and short-term RS trends.

So which sectors, other than the utilities, look the best as we head into the end of the year?

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Chart Analysis: There has been much debate over the past few months about the health of the consumer, as well as how robust a Christmas season one should expect.

One sector often thought of as recession proof is the Select Sector SPDR Consumer Staples (XLP), but it also came under heavy selling pressure in August, dropping briefly to a low of $28.07 as the support from the 2010 highs was tested.

  • The drop in XLP early in the week came close to the August lows (28.70), but it is now trading well above the lows
  • The RS analysis broke its weekly downtrend (line c) in April, signaling that XLP was starting to outperform the S&P 500
  • The RS now shows a strong uptrend (line d), and this is the key support level to watch
  • The on-balance-volume (OBV) pattern in XLP looks the strongest of any sector other than the utilities. It is very close now to making new highs, with important support at line e
  • The upper boundary of the weekly trading range is at $30.55 to $31.14 (line a). In May, XLP had a high of $32.46

While it is easy to argue that all consumers will continue to buy staple items no matter what, the outlook for discretionary spending is less clear.

As I mentioned earlier in the week, we are in a strong seasonal period for retail apparel, so it is no surprise that I continue to like the Select Sector SPDR Consumer Discretionary (XLY).

  • Though XLY did break the August lows on Tuesday, with the low at $33.07, the rebound has been sharp, and it is now 10% above the lows. This is very bullish, as it is likely the weak longs were stopped out
  • There is next resistance at $37.55 and then at $37.91(line f). A move above this level should signal a rally to the $41 area
  • The daily RS analysis stayed strong on the drop this week, as it held well above its uptrend (line h), and it is acting stronger than prices
  • The daily OBV does not look nearly as strong, as selling was heavy in August. It is back above its WMA with key resistance at line i

NEXT: 2 More Top Sectors for Year End

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The Select Sector SPDR Health Care (XLV) has been one of my favorite sectors since early in 2011, but I was also surprised by the severity of the summer decline.

  • The weekly chart shows support now sits in the $30 area, with the August lows at $29.64
  • The RS is still in a healthy uptrend (line c), despite the recent drop
  • The OBV broke below support (line d) before the selling became heavy, and though it has improved, it is still below its WMA
  • Next resistance for XLV comes at $32.88, with stronger levels at $33.35 to $33.75

The Select Sector SPDR Technology (XLK) has been acting much better than the overall market since July, and has done over 4% better than the S&P 500 this year. The test of the August lows at $22.47 seems to have been successful, as XLK only reached a low this week of $22.60.

  • The RS line surged through weekly resistance (line g) at the end of July, and made a new high just a week ago.
  • It is leading prices higher, which increases the odds that tech will also start to accelerate to the upside.
  • The weekly OBV violated support (line h) in May, and is still negative. Despite the sharp rally over the past few days, the daily OBV (not shown) is still negative.
  • A weekly close above the resistance at $25.29 should signal a test of the resistance in the $26.80 area.

What it Means: Being in the strongest sector is important whether the stock market is in an uptrend or downtrend. The stronger than expected jobs numbers early Friday are positive for stocks in early trading, and if the market can continue higher for the next two days a bottom formation could be completed.

If this is the case, a minor pullback in the next week should be an opportunity to buy some of the strongest sectors.

How to Profit: As recommended in mid-August, investors should be 50% long the Select Sector SPDR Consumer Staples (XLP) at $29.08 and 50% long at $28.88, with a stop at $27.96. Those not long could buy at $29.82 with a stop at $27.96.

Our buying zone was also hit this week in the Select Sector SPDR Technology (XLK). Buyers should be 50% long at $23.66 and 50% long at $23.12, with a stop at $21.74. Those not long could buy at $23.88 with a stop at $22.28.

The Select Sector SPDR Utilities (XLU) never made it to the recommended buying zone. Therefore, go 50% long at $32.94 and 50% long at $32.56, with a stop at $31.18 (risk of approx. 4.8%).

Go 50% long the Select Sector SPDR Consumer Discretionary (XLY) at $35.32 and 50% long at $34.76, with a stop at $32.78 (risk of approx. 6.4%)

Go 50% long the Select Sector SPDR Health Care (XLV) at $31.32 and 50% long at $30.76, with a stop at $29.32 (risk of approx. 5.5%)

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