Summer Sector Scan

08/26/2010 3:30 pm EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

By anyone’s definition, it has been a choppy summer for the stock market. While some of the measures of the stock market’s trend are positive, others are decidedly negative. Some market averages have violated the February lows, while others have not. There have also been some significant changes in the relative strength (RS), or relative performance analysis of the major sectors. 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.

I do expect liquidity to return to the markets after Labor Day, if not sooner, and a close look at the major sectors should better prepare you for the last quarter of trading. As we head into the last two weeks of trading before the holiday, the stock market looks ready to decline back toward the summer lows. Currently, the more defensive sectors are looking the best; however, this is not surprising.


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The S&P Telecommunications Services sector tested the weekly support in July (line b) and is approaching key weekly resistance in the 116.50 area (line a). If this level is overcome, it should rally to the 123 level, if not the longer-term resistance at 130. The lower close this week suggests that the rally may be losing steam. The RS moved through its well-established downtrend in March 2010 (line c) and by April (line 1) was clearly above its rising MA. Though the sector has been one of the stronger performers over the past six weeks, a strong move above resistance (line d) is needed to indicate that a significant low is in place. Two of the most widely held stocks in this sector, AT&T (T) and Verizon (VZ) both yield over 6%.


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The S&P Utilities sector moved through nine-month resistance in July, line b. It is still below major resistance in the 159-160 area (line a). The year-long downtrend in the RS was broken in June (line 1) and that signaled the utilities had taken over leadership from the S&P 500. Given the weak stock market performance in May and the search for good yields outside of the bond market, this should not have been surprising. The RS has held its uptrend as it is now approaching longer-term resistance (line d). A move through more important RS resistance at line d is likely and should be enough to propel the sector above the 160 level.

NEXT: Health Care, Consumer Staples, and More

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Health care is also a more defensive sector, though it has been in a trading range over the past few months after breaking its weekly uptrend (line c) early in 2010. Major resistance at 380-390 (line a) was tested in late 2009 and was not overcome on the rebound early in 2010. The RS analysis has been negative to neutral since March 2009 (point 2), when it dropped back below its moving average (MA). So far, the RS has been holding long-term support at line d, but needs to move through resistance at line e in order to suggest it is again ready to outperform the S&P 500.


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The weekly chart of the S&P Consumer Staples sector is quite interesting on a number of levels. The major resistance from the 2008 highs (line a) was tested in April/May, but the sector was unable to move through it. After declining back to the 260 area, the sector once again bounced back to 280. There are two ways to look at the weekly formation since October 2009. One is that we are currently forming the right shoulder of a head-and-shoulders top formation with the neckline in the 260 area (dashed line). A break of this level will project a decline to the 230 level. The other alternative is that the action since the April highs is part of a continuation pattern that will eventually be resolved by a rally above resistance (line a). The RS chart has been locked in a range (lines b and c) over the past year and the RS is still holding its rising MA. A strong move above resistance (line b) would be a clear indication that this sector is likely to outperform the S&P over the next few months.


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I wanted to take a shorter-term look at a few of the sectors that are thought to have an important impact on the health of the economy. The Consumer Discretionary sector is widely watched as many feel the economic recovery can’t last without consumer spending. The rebound in the sector from the July lows just took it back to resistance formed in June (line a), which is not a positive sign. There is daily chart support not far below current levels at 235, and if it is broken, it could set the stage for a decline to the February lows and major support in the 222 area. The daily RS is still holding in a range (lines c and d) and is not giving us any strong signals. However, the weekly and monthly technical analysis on the sector does not yet suggest that a major top has been completed.

NEXT: Materials, Energy, Tech, and More

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The Materials sector just made a marginal new high in April (213.80 versus 213.50 in January) and the recent rally has stalled, so far, below 200 (line a). Clearly a move above this level is needed to turn the daily chart positive. There is key daily support now at 179 (line b) and then more important support in the 168 area. Since the July lows, the materials have been doing better than the S&P 500 as the RS formed a higher low and then overcame its downtrend (line d). The key daily resistance in the RS (line e) has just been tested, and I will be closely monitoring the RS at line f.


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The short-term technical action of the Energy sector is decidedly more negative as after the rebound to the 420 area and the flattening of the 200-day MA, the sector turned lower. The sector is now approaching the mid-July lows at 386, which are likely to be broken. There is more important support in the 365-377 area (line a). The daily RS has been declining since June 2009 (line b) and the recent move through this downtrend does not look significant. If the RS can move above the resistance at line c it would be more encouraging. Volume analysis of the sector does not yet show any heavy selling pressure.


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The technology stocks have been weaker than the S&P 500 since the April highs. The weekly chart of the Information Technology sector shows a tight range between resistance at 363-368 (line a) and support in the 325 area (line b). Decisive violation of this level would project a move to the 280 area. The trading range in the RS analysis is consistent with a lack of leadership from the technology sector as it has formed lower highs since the December peak (line c). Thus far, the key support (line d) is still holding. A drop below this support would be the first sign that a more serious decline was underway.

NEXT: Lesson Concludes with a Look at Industrials and Financials

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The Industrials sector was one of the strongest during the rally from the July lows, as it quickly surpassed the prior peak at 266 and reached 269 before reversing to the downside. There is well-established support (line a) in the 232.50 area. The weekly RS analysis is positive as the uptrend from last year’s lows (line c) was tested in July and is still holding. The only slight reason for concern is that the RS line made a lower high in August and is now declining towards its rising WMA. It would take quite a few weeks of further weakness to turn the RS analysis negative.


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The daily action in the Financials sector is much more negative as it has reached a band of more important support in the 177-185 area. The formidable resistance in the 203 area has contained all of the rallies over the past three months and would have to be overcome to signal resurgence in the financial stocks. The RS analysis suggests this may not happen in the near future as year-long support (line c) has just been violated. This reinforces the decline in the RS (line b). The weekly and daily studies are negative for the sector but are not yet showing any signs of downward acceleration.

So what is the strategy for the coming months? I think the strength in the utilities and telecommunications can continue, both because of their better relative performance as well as generally higher yields. In order to monitor the health of the market and the success of the economic recovery, I will be closely monitoring the Information Technology, Financials, Materials, and Industrials sectors. If two or more of them violate major support, it will increase the probability that the stock market rally from the 2009 lows is over. Look for updates on these sectors in our daily Charts Traders Are Watching feature.

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