In part 1 of our commentary, we discussed the current Fundamental Gravity of our “U.S. Shift Work” macro theme. If you missed Part 1, I would encourage you to read through that first, writes Landon Whaley Friday. He's presenting at MoneyShow Toronto Sept. 15.

We covered a great deal of critical fundamental developments, which are bearishly impacting financial stocks and the U.S.-listed ETF, the Financial Select Sector SPDR ETF (XLF).

Quantitative Gravity says what?

As a quick reminder, the Quantitative Gravity component of our Gravitational Framework is not technical analysis, which is ineffective and misleading. Rather, we use quantitative measures based on the reality that financial markets are a nonlinear, chaotic system.

We’ve identified four primary quantitative dimensions of financial markets that affect price movement: energy (trend), force (momentum), rate of force (buying pressure), and a market’s irregularity (level of imminent drawdown risk).

chart 1

Social is our measure of a market’s current energy (or trend). XLF’s Social reading indicates it is asleep despite its most recent two-week, +2.6% bounce. Given the Fundamental Gravity, the most likely trend for XLF when it awakes is a bearish hangover.

Momo is our measure of the amount of force behind the market’s current state. XLF’s Momo has been benignly bullish since July 18, but it’s been losing bullish strength during the entire price bounce since August 15.

chart 2

Barometric is our measure of buying and selling pressure or the rate of force behind the current Momo. XLF’s Barometric indicates a fair fight between buyers and sellers. However, sellers have been primarily in control of this market since February, which is why XLF is trading today exactly where it was trading on February 7.

chart 3

Topo, which measures the probability of a drawdown, is indicating a rising level of drawdown risk for XLF over the next 10 trading days. Until last week, there was an extremely low level of drawdown risk in XLF for the proceeding two months. At the margin, this is an extremely bearish development.

chart 4

Alpine and Abyss Lines

Our proprietary Alpine and Abyss lines are not “support” and “resistance.” Rather, they are the areas above and below the most recent closing price where price is likely to experience an acceleration in its current trajectory, or a possible reversal of its current course. We calculate these critical prices utilizing fractal geometry and Chaos Theory as the foundation to analyze the underlying market structure, which is not visible on a price chart.

When a particular market’s price interacts with the Alpine or Abyss areas, regardless of whether the price is rejected by the Alpine or Abyss area or is able to breakout above (or breakdown below) it, the outcome gives you critical insight into the most likely direction of that market.

The most critical Alpine area for XLF above Friday’s closing price is between $28.56 and $28.96. This means that it’s highly likely that any upside price momentum will stall at this area. However, if XLF closes decisively above that area, price is likely to accelerate higher from there.

The most critical Abyss area for XLF below Friday’s closing price is between $27.73 and $27.35. This means that it’s highly likely that any downside price momentum will stall at this area. However, if XLF closes decisively below that area, price is likely to accelerate lower from there.

The Quantitative Gravity bottom line is that XLF isn’t bearish yet, but it’s becoming less bullish. Remember, every bear market begins as a bull market that gets less bullish. The best shorting opportunity is when the phase transition from bull to bear is occurring, not once it’s complete.

Behavioral Gravity says what?

Behavioral Gravity allows us to evaluate investors’ perception of this market and how that perception changes and shifts over time.

The Behavioral Gravity Index (BGI) for XLF has been extremely bullish for several months now, but that changed on August 9, when the BGI flipped to a bearish reading for the first time since February. That said, investors have plowed an additional $279MM into XLF in just the last eight weeks.

The Behavioral Gravity bottom line is that while the BGI is flashing bearish, being short U.S. financial stocks is far from a consensus trade. There is a very low behavioral risk to initiating (or holding) short positions in XLF.

The Trade Idea

As long as XLF trades below $28.96, new short trade ideas can be initiated opportunistically on rallies. Depending on your entry and how much room you want to give this trade idea to move, use a risk price between $28.56 and $28.96. That said, your risk price line in the sand is $28.96. If XLF closes above that price, exit any open trades. If the trade moves in your favor and XLF trades down to the $27.35 area, consider closing some, or all, of your position.

In addition to providing detailed analysis and trade ideas like this commentary on a weekly basis, we also provide real-time email alerts whenever we add, or close, a position in our Asset Allocation model inside our Gravitational Edge report.

We are currently out of XLF in our Asset Allocation Model and will send out an alert if we get the right entry price that skews the reward-to-risk characteristics of the short trade in our favor.

Please email us at ClientServices@WhaleyGlobalResearch.com if you’d like to receive an email alert when we initiate our position and participate in a an eight-week free trial of our research offering, which consists of three weekly reports: Gravitational Edge, The 358, and The Weekender.