Where’s the Line in the Sand for This Selloff?

by Daniel Putnam | June 5, 2012 8:54 am

Where’s the Line in the Sand for This Selloff?

The current market environment presents a monumental challenge for investors and traders alike. Valuations seem reasonable for the market in general, and many stocks in the cyclical sectors are off well more than 50%.

It might look like a buying opportunity, but without a stabilization in the broader market, even the most beaten-up sectors will continue to be a source of pain for investors. As a result, the key challenge to assessing any individual stock right now is determining whether this selloff is a simple correction or the beginning of another 2008-style meltdown.

As is often the case, the technical picture provides some insight. And the Select Sector Energy SPDR (NYSE:XLE[1]) might be the most important security to monitor to help you draw your “line in the sand.”

Why energy? Since concerns about the global economy are the main factor driving weakness in stock prices in recent months, energy shares have been an excellent barometer for investor fear. XLE was among the first sector ETFs to break down in the 2011 summer downturn, and it also was one of the first to test its 200-day moving average in the current selloff. Now, it also might be the first to break below its long-term trendline.

The chart below provides an illustration of how close the energy sector is to more serious bear market territory. Currently, XLE only needs to fall 5.1% to violate its lower trendline at $58.81. Keep in mind, though, the specific breakdown point on a lower trendline rises a little every day.

1charts 1024x424 Where’s the Line in the Sand for This Selloff?[2]

XLB’s performance around its trendline is important because the broader market — as gauged by the SPDR S&P 500 ETF (NYSE:SPY[3]) — still is 7.8% from reaching its lower trendline. A breakdown in materials therefore will serve as an early warning sign. A break by the Select Sector Industrials SPDR (NYSE:XLI[4]), which also is closer to its lower trendline than the S&P, will serve as a confirmation.

While XLE’s trendline is an important reference point for the market as a whole, it doesn’t tell us whether the energy ETF will be able to hold this line. There are, however, some other markets whose charts might be able to provide some clues. The bad news is they aren’t telling a positive story right now.

The charts in question represent large, important asset classes: iShares Trust MSCI EAFE Index Fund (NYSE:EFA[5]), iShares MSCI Emerging Markets Index Fund (NYSE:EEM[6]) and PowerShares DB Commodity Index Tracking Fund (NYSE:DBC[7]). These three charts are similar in that they already have broken the lower trendline that XLE soon might test.

Drilling down further, the charts of other stocks and ETFs with high economic sensitivity — PowerShares DB Base Metals Fund (NYSE:DBB[8]), Market Vectors Steel Index Fund (NYSE:SLX[9]) and Freeport McMoran Copper & Gold (NYSE:FCX[10]), to name a few — have not only broken their lower trendlines, but in some cases they are in jeopardy of falling beneath their 2011 lows.

2charts1 300x124 Where’s the Line in the Sand for This Selloff?
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3charts 300x125 Where’s the Line in the Sand for This Selloff?
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4charts 300x132 Where’s the Line in the Sand for This Selloff?
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5charts 300x121 Where’s the Line in the Sand for This Selloff?
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The fact all of these key indicators have broken down certainly doesn’t guarantee that a similar breakdown in energy is in store, but it does raise the odds.

XLE isn’t the only sector approaching a key support level. In fact, the majority of the sector ETFs are within 5%-8% of violating similar, multiyear trendlines. The table below shows Monday’s close, the breakdown level and the percent decline needed to move into dangerous technical territory. Monitor these levels closely in the weeks ahead:

Sector ETF Breakdown Level % Drop Needed for Breakdown
Telecommunications IYZ $20.48 1.7%
Energy XLE $58.81 5.1%
Consumer Staples XLP $31.18 6.1%
Industrials XLI $31.02 7.2%
Materials XLB $30.47 7.8%
Financials XLI $12.30 7.8%
Technology XLK $31.18 8.0%
Health Care XLV $32.46 8.7%
Consumer Discretionary XLY $37.79 9.6%
Utilities XLU $32.00 10.7%

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Endnotes:
  1. XLE: http://studio-5.financialcontent.com/investplace/quote?Symbol=XLB
  2. [Image]: http://investorplace.com/wp-content/uploads/2012/06/1charts.jpg
  3. SPY: http://studio-5.financialcontent.com/investplace/quote?Symbol=SPY
  4. XLI: http://studio-5.financialcontent.com/investplace/quote?Symbol=XLE
  5. EFA: http://studio-5.financialcontent.com/investplace/quote?Symbol=EFA
  6. EEM: http://studio-5.financialcontent.com/investplace/quote?Symbol=EEM
  7. DBC: http://studio-5.financialcontent.com/investplace/quote?Symbol=DBC
  8. DBB: http://studio-5.financialcontent.com/investplace/quote?Symbol=DBB
  9. SLX: http://studio-5.financialcontent.com/investplace/quote?Symbol=SLX
  10. FCX: http://studio-5.financialcontent.com/investplace/quote?Symbol=FCX

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