Sector Analysis: May 15, 2009

05/21/2009 12:00 pm EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

Much has transpired since our last look at the major sectors as of the close on December 12, 2008. The S&P 500 dropped from its closing level of 885.80 to a low of 666.80 and closed this past Friday (May 15) at 882.50. In my view, since there is a good possibility that we will not see a substantial break below the March lows for a while, it is a good time to look for the leading sectors, as those are the ones that should be bought on any correction.

Table 1

The table above covers the ten major sectors along with the S&P 500. I have taken the closing price on May 15, the closing price from the last full sector review (Dec. 12, 2008), and the low price that each sector made in March. In the last two columns, I have used this data to calculate both the change from the March lows and the change since the Dec. 12, 2008 close. Several things stand out, the first of which is the well-discussed 97% gain in the financials from the March lows, but as I will discuss later, the long-term technical picture for this sector does not suggest that it has completed a major bottom. Three groups are up over 40% from the March lows, including materials, industrials, and consumer discretionary. Two of these sectors are also showing nice gains from the December 12 close, and these two will be a focus after first examining the technical outlook for the S&P 500.

Figure 1

The S&P's rally from the March lows has been dramatic, as it is now approaching strong resistance in the 943-950 area along with the 200-day MA. This suggests that significant gains from current levels may be difficult in the near term. The five-week positive divergence in the weekly RSI on the S&P 500 (line b), which was confirmed by the move through resistance at line a, is normally consistent with an intermediate-term low. Over the next three to five weeks, I see two likely scenarios. One is that the market will push higher from current levels and test the 1000+ area, squeezing out many of the short positions. The other scenario is that we will retest and possibly exceed the recent highs before a one- to three-week correction. This fits best with the RSI formation, as such a move would take the RSI back to good support (see circle) and set the stage for a resumption of the intermediate-term uptrend. There is initial chart support now in the 850-870 area, with the 38% retracement support from the recent highs at 930 now at 830.  A move above 930 should signal quite a short squeeze. The current 50% support level is at 800. A daily close below 770 would indicate that the rally from the March lows is over.

Figure 2

If you have not read any of my earlier articles on sector analysis, I use a relative performance, or relative strength (RS), which is determined by calculating a ratio of the sector price to the S&P 500 When the RS line is rising, it means that the sector is performing better than the S&P 500. Conversely, if it is declining, it is underperforming. Then, we also look at breakouts or breakdowns for changes in the relative performance. The S&P Materials Sector has had an impressive rally from the March lows as the weekly technical studies formed higher lows than in November 2007 despite the lower lows in price. It is also positive that the sector moved well above the late-2008 highs. The RS chart shows that by August 8, 2008 it was well below its WMA (line a), which was clearly declining. The RS started to flatten out late in the year, and as noted in December, had reached long-term support. The RS was above its WMA at the March lows, and by the close on March 19 (line b), it was well above its rising WMA. This is one of the few sectors that is up from the December 12 closing levels. A correction down to the 130-40 area should be a good buying opportunity.

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Figure 3

The consumer discretionary sector is one I have been watching for the past year as the RS formed a triple bottom in 2008 that was confirmed two weeks after the March lows (line 1) as the downtrend in the RS (line d) was broken. This was noted on our daily chart study on March 27. The RS also formed a nice positive divergence at the lows (line e). The chart shows that the rally was able to move above the highs formed in late 2008 and early 2009, as the sector quickly approaches the long-term resistance in the 200-220 area. A pullback to the support in the 150-165 area should present a good buying opportunity.

Figure 4

The information technology (Tech) sector was covered in detail in a previous article, and even though it is up just 32% from the March lows, it shows good relative performance since December. The daily RS broke out on March 4, suggesting it was the sector to be in. The MACD-Histogram turned positive with the close on January 9, 2009 (point 1). The MACD-His stayed positive throughout the decline into the March lows and rose the week after the lows with the bullish weekly formation (point 2). The MACD-His has continued to maker higher highs as the sector is now approaching the resistance from the 2005-2006 lows in the 285 area. The longer-term downtrend is now in the 315-320 area. There is good chart and first retracement support now in the 248 area with the 50% support at 238. A decisive close below 227 would be negative. On a correction, I would expect the 240-250 level to hold.

Figure 5

I have been surprised by the strength of the industrial sector from the March lows as it is up 46%, but is still down from the December 12 close. Technically, this just looks like an oversold rally as the chart or RS show no signs yet of a completed bottom formation. The sector is still below the previous highs and even further below the 38% resistance and longer-term downtrend (line a), which are in the 235 area. The RS is above its WMA, which has just flattened out and has quite a ways to go before it could challenge the downtrend (line b). I would expect this sector to be weak on any deeper correction.

Figure 6

The action in the energy sector has been disappointing, as the sector had reached long-term support last fall going back to 2005 (line b). This combined with the RS moving above its WMA was a signal that I found encouraging. However, the RS failed to make much upward progress this year and on April 15, as I noted at the time, the RS was back below its WMA (point 1). The RS recently tested its declining WMA (point 2) before turning lower. Long-term RS support was also approached in October and I would still expect the RS to hold these levels.  The weekly chart still shows a trading range (lines a and b), so a convincing move above the recent highs along with significant improvement in the RS is needed to indicate that this sector is outperforming.

Figure 7

As I noted earlier, the standout from Table 1 is the financial sector, up a whopping 97% from the lows, as the panic selling in the bank shares created an extremely oversold condition. Looking at the weekly chart, however, there are no strong signs that this sector has completed a significant low, as V-shaped bottoms are rare. The rally has just tested the 23.6% retracement resistance and the downtrend from the all-time highs. There is still massive resistance in the 250 area. The RS is above its WMA, which is now trying to run higher, but it is still below the downtrend from the 2007 highs. We should get a get a clearer picture of this group on the first significant setback, and if it does retest the lows, it would look much more interesting.

Figure 8

As one would expect, the more defensive sectors of consumer staples and health care are only up 17% from the March lows. Neither group has made it above the previous peaks and the resistance from late 2008. The RS for consumer staples formed what may be a double top at the March lows, and then dropped below its WMA. The major breakout through resistance in 2008 (line a) appears to be significant, and so far, the uptrend (line b) is holding. The heath care sector shows some similarities even though it just made a marginal new low in March. The RS is now well below its WMA but is still holding above the breakout level (point d). If the market does undergo a serious decline, funds should flow back into these sectors.

Over the next few months, a substantial correction in the overall stock market is likely to occur. Careful monitoring of the major sectors on this correction will be important. With the current action, I would expect the leadership after the correction to come from the technology, materials, and consumer discretionary sectors.

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