The Week Ahead: Three Sectors to Watch in May

05/01/2015 5:00 pm EST

Focus: MARKETS

Thomas Aspray

, Professional Trader & Analyst

The declines in most of the major averages last week erased much of the months’ gains, but since MoneyShow's Tom Aspray thinks the technical studies need to be the trigger to act on any seasonal tendencies, he takes to the charts to determine which sectors to watch in May.

The stock market ended the month on a rough note as stocks dropped sharply last Thursday. The 1% declines in most of the major averages erased much of the months’ gains as the Dow Industrials was up just 0.4%, while the S&P 500 was up 0.85%. If the market can hold its gains into the close on Friday, it should help soothe investors.

On Thursday, the market was still trying to digest the very weak advance reading on GDP that was released Wednesday as well as the plunging social media stocks. The hot sectors—like the iShares Nasdaq Biotechnology (IBB)—were down over 3% on Thursday. The IBB was down 2.84% for the month but is still up 9.9% YTD.

The bad earnings started out with the snafu over Twitter’s (TWTR) earnings on Tuesday, which was followed by misses in both Yelp, Inc. (YELP) on Wednesday and LinkedIn Corp. (LNKD) as it opened down over 18% on Friday. The technical outlook for the social media stocks was the focus of last week’s trading lesson Are Social Media Stocks Dead or Just Resting?

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It has been a tough year for stock investors as the best index gainer has been the PowerShares QQQ Trust (QQQ) which is up 4.48% so far this year. The choppy action has made it hard to be in the right sector at the right time.

The most surprising performance came from the energy sector as the SPDR S&P Oil & Gas Exploration (XOP) is up 13.3% so far in 2015. At the January lows it was down well over 12% for the year, so it has had quite a turnaround. In early February’s Crude Oil Money Flow Turns Positive, I noted the improvement in the technical outlook for crude oil.

The high degree of bearish sentiment created the perfect environment for a rally and crude oil started the 2nd quarter with a positive trend. It still looks strong technically as it has overcome major resistance and the money flow is positive for the first time since last August (see chart).

Healthcare has been my favorite sector in 2015 as the Sector Select Health Care (XLV) was up over 9% just over a week ago. It now is just up 5.5%. The biotech stocks need to rally sharply from current levels to avoid a deeper correction.

One of the big disappointments in 2015 has been the iShares Transportation Average (IYT) as the Dow Transports has failed to confirm the new highs in the Dow Industrials. The longer-term charts do not suggest that a major top is in place, but the current drop of 5.3% in IYT has made it a sector to avoid.

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So, which are the sectors to watch in May? In the past, I have often discussed seasonal analysis and have always emphasized that the technical studies need to be the trigger to act on any seasonal tendencies. The seasonal chart of SPDR S&P Oil & Gas Exploration (XOP) shows that it typically peaks on June 13 (line 1) and then bottoms on December 12 (line 2).

Crude oil has a strong tendency to bottom in February. The current technical outlook (Crude's 2nd Quarter Strength on Track) on both crude and the XOP indicates they can move higher during May. This will require that both make new rally highs by the middle of the month.

As portrayed in the first chart, the Sector Select Consumer Staples (XLP) has been holding in slightly positive territory for most of the year. If XLP moves above 3.7% for the year, it will be an indication that it is now becoming a market leader.

The seasonal trend for XLP is for it top on December 5 (line 3) and decline into a low around March 6 (line 4). This rally typically tops out on May 15. XLP is currently testing its quarterly pivot at $48.68 and a weekly close below $47.30 would be a sign of weakness. On the upside, a weekly close above the $50 level would be an upside breakout.

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Healthcare has been a leading sector since it broke out of a 12 year trading range in 2012.  In 2012 it was up 17.4%, gained 41.4% in 2013, and 25.1% in 2014. With such an impressive three-year record, it is not surprising that it has not followed its prior seasonal pattern.

Historically, it forms an initial peak in January (line 1) and then forms a secondary high on April 25 (line 2). Typically, the decline lasts until October 17 (line 3). Instead, in 2014, XLV rallied from the April lows, and after a brief correction in October, finished the year strong. On a technical basis, XLV tested its quarterly pivot at $71.78 last week and there is further chart support, line a, in the $70 area.

The monthly chart shows that the OBV has been positive since December 2011 when it moved above its WMA. It has stayed strong and well above its WMA. The OBV made a new high in March and is still well above long-term support at line b. There are no signs of a major top but a deeper correction is possible.

In addition to the weak earnings and deteriorating economic data, the market has been impacted by the sharp drop in the EuroZone stock markets as the dollar has weakened. With so many traders betting on a lower euro, a sharp short covering rally was not surprising.

The Euro markets, like the German Dax, have been hurt by the euro’s strength and the selling has carried over to the US. The Dax is already near good support as it closed Friday at 11,545, which is still above the quarterly pivot at 11,189. Therefore, the strength of the next rally will be important.

NEXT PAGE: What to Watch

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Contrary to the weak GDP report, the Chicago Purchasing Managers Index rose to 52.3 in April, up from 46.3 in March. Pending Home Sales were also up again last month. This is consistent with the Fed’s view that the weak 1st quarter data was just a result of the winter weather. Friday’s PMI Manufacturing Index and ISM Manufacturing Index came in just a bit weaker than expected.

There was some mixed news on the consumer last week as the Conference Board’s Consumer Confidence fell to 96.1 from 101.5 the previous month. The market was expecting 103. But Friday’s Consumer Sentiment from the University of Michigan held firm at 95.9. The report suggests a positive outlook on consumer spending and the job market.

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While the overall the economic data makes it less likely that the Fed will raise rates before September, the surprising increase of 0.7% in the Employment Cost Index may have caught them by surprise. This is a measure of total employment compensation and may be a sign of more inflation in the coming months. The chart looks bullish after the breakout in 2014, line a, and looks as though it can move even higher.

This week the focus will be on jobs, with the monthly report on Friday and the ADP Employment Report on Wednesday. We get Factory Orders on Monday with the PMI Services Index and the ISM Non-Manufacturing Index on Tuesday.

What to Watch

The market bears clearly took over last week but the correction stopped right where it needed to in order to avoid causing more technical damage. This makes the action early this week quite important. If the recent upside breakout was legitimate, the market should move sharply higher and make new highs in the next week or so.

This is still consistent with the technical outlook for the NYSE Composite, Spyder Trust (SPY) and the Powershares QQQ Trust (QQQ). The negative input comes from the further technical deterioration in the iShares Russell 2000 (IWM) which suggests a 2-3 day rebound could fail.

There has been little change in the AAII sentiment over the past week as the bullish % dropped slightly to 30.84% with the bearish sentiment at 21.9%. The neutral camp has hit its highest level of the year at 47.21%.

The market is not overbought basis the number of stocks above their 50-day MAs as the readings are pretty neutral. On a further correction they are more likely to move into oversold territory.

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The daily chart of the NYSE Composite shows that it dropped down to the support in the 11,000 area, line a, on Thursday’s drop. The daily starc- band is now at 10,971 with the quarterly pivot at 10,828. The low in early April was 10,834 with the uptrend from the December lows, line b, at 10,750.

The flat 20-day EMA is now at 11,102. A daily close back above 11,200 is needed to indicate the pullback is over, with the daily starc+ band at 11,527. The quarterly projected pivot resistance at 11,527.

The daily NYSE Advance/Decline line has dropped back below its WMA which is now starting to flatten out. The longer-term uptrend is now being tested with next good support at the March highs.

The McClellan oscillator has dropped sharply and it is now moderately oversold at -201. It bottomed at -190 in March and hit -250 last December.

NEXT PAGE: Stocks

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S&P 500
The Spyder Trust (SPY) was able to rebound back above Thursday’s high on Friday, which is an encouraging sign as it also looks ready to close back above its 20-day EMA. A daily close back above $211.50 would be positive. The daily starc+ band is at $214.28.

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The starc- band was violated on Thursday, and if that low at $207.62 is violated, the next support is at $207. There is additional chart support at $206 (line b) with the quarterly pivot at $204.90.

The S&P 500 A/D line has reversed sharply after making a new high and has dropped back below its WMA. The uptrend, line c, is the next important level of support to watch.

The daily OBV has turned lower after testing the resistance at line d. The weekly OBV (not shown) has dropped back below its WMA.

Dow Industrials
The SPDR Dow Industrials (DIA) held up pretty well last week as the earnings for some of the big oil companies—as I expected—were not as bad as most analysts thought. A daily close back above $181 would be a good sign with the daily starc+ band at $183.65.

DIA needs a strong close above the March 2nd high of $182.24 to make a new all time high.

The daily Dow Industrials A/D line made a new high for the year last week but is still below the December 2014 high. It has dropped back below its WMA with more important support at line g.

The daily OBV has important resistance now at line h, as it dropped below its WMA last week. It did turn up on Friday and is still in an uptrend.

Nasdaq 100
The PowerShares QQQ Trust (QQQ) dropped down to test the starc- band last Thursday as it had a low of $107.06. This was also a test of the short-term uptrend, with the quarterly pivot at $104.68. There is additional support, line a, at $103.50.

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The 20-day EMA is at $108.22 and still rising gradually.  A daily close above $111 would be consistent with the end of the correction, with the daily starc+ band at $112.63.

The daily Nasdaq 100 A/D dropped back below its WMA last week but will likely turn higher after Friday’s close. A drop below the support at line c and the mid-April low would be a sign of weakness.

The OBV quickly dropped back to support last week  after making a marginal new high the previous Friday.

Russell 2000
The iShares Russell 2000 (IWM) had a wide range last week, as after reaching a high of $126.91 on Monday, it dropped as low as $120.66 last Thursday as support at line e, was tested.

The low was below the daily starc- band.  The quarterly pivot at $121.39 was also violated and IWM is now struggling to close above it on Friday. The quarterly pivot support is at $116.83.

The now declining 20-day EMA is at $124.36 and may now provide strong resistance. The daily starc+ band is at $126.83.

The daily Russell 2000 A/D spiked to a new high last Tuesday but now looks ready to close below its uptrend.  The April lows are also being tested. The WMA of the A/D line is also starting to turn lower, which is a sign of weakness.

The daily OBV dropped sharply last week as it violated the uptrend, line g. A rally back to its flat WMA will need to be watched closely.

NEXT PAGE: Sector Focus, Commodities, and Tom's Outlook

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Sector Focus
It was a disappointing week for the iShares Dow Jones Transportation (IYT) as after the prior week’s rally it closed lower again this week. It will close below the quarterly pivot at $158.78 despite Friday’s rally. It is also below the 20-day EMA at $156.97.

The weekly relative performance and OBV are both below their WMAs and negative. The daily technical studies are also negative.

Four of the sector ETFs are still negative for the year, including the Select Sector Industrials (XLI) down 0.5%, Select Sector Utilities (XLU) down 5.8% , Select Sector Financials (XLF) down 1.6%, and the iShares Dow Jones Transportation (IYT) which has lost 4.6% for the year.

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The Select Sector Health Care (XLV) lost over 2% last week as it is now only up 6.3% for the year, while the Select Sector Consumer Discretionary (XLY) is getting closer to XLV as it is up 5.8%.

The Sector Select Technology (XLK) was down a bit for the week, while the Sector Energy (XLE) was higher, now up 4.7% of the year.

The defensive Select Sector Consumer Staples (XLP) is just barely positive for the year up 0.7% but may be a surprise this month.

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Interest Rates
As the chart indicates, yields rose sharply last week from 1.917% to close at 2.117%. The daily downtrend from last September’s high, line a, is now being tested. A close above the early March high at 2.26% would suggest that yields may have bottomed. The yields are well above the rising 20-day EMA at 1.968%.

Precious Metals
As I mentioned two weeks ago, the outlook for the metals was negative. Both the SPDR Gold Trust (GLD) and Market Vectors Gold Miners (GDX) closed a bit higher but still well below the key resistance levels I identified in Bond King Likes Gold, Should You? The daily OBV on GLD made new lows on Friday but the GDX is acting better.

The Week Ahead
Though I continue to think that the recent upside breakout was legitimate (Fake Out or Breakout?) last week’s action has weakened the technical outlook. Typically, this means that the rally needs to resume soon in impressive fashion to avoid a deeper correction.

Clearly, the wall of worry has continued to keep many investors on the sidelines and a lower close this week will increase the odds of an 8-10% correction. Normally it would take several weeks to develop a top that would signal even a deeper drop.

Since I was expecting new highs as noted in (Profit Taking Levels for SPY, IWM, and QQQ) I will be watching the action early in the week closely to see whether we need to reduce these long positions. Look to Twitter for the most timely updates.

For those in the process of establishing a  dollar cost averaging position—as I recommended two weeks ago—stay with your plan. There are no signs of a bear market or a recession so I continue to think that stocks are the best bets.

Volume has been light so far in 2015 and could be even lighter as we head into the summer months. This will likely increase the volatility, which makes it more important that each of you determine your risk tolerance level and therefore what percentage of your portfolio you are willing to have in the stock market.  

Don't forget to read Tom's latest Trading Lesson, Are Social Media Stocks Dead or Just Resting?

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