by Daniel Putnam | October 16, 2013 9:30 am
The stock market has overcome a variety of headwinds in its march higher this year, and both mid- and small-caps crossed into record-high territory on Monday.
But underneath the surface, this market is flashing some warning signs. If there’s a meaningful rally in the next one to two weeks, these signals can be dismissed; otherwise investors should consider taking steps to protect their portfolios.
The potential cause for concern is the series of slightly lower highs being printed by a number of key market segments. Even as the charts of headline indices such as the S&P 500 continue to show an uptrend, the same can’t be said for specific sectors like Financials, Consumer Staples and Utilities, which in combination make up nearly 30% of the market.
Just take a look at charts of the Financial SPDR (XLF), Consumer Staples SPDR (XLP) and Utilities SPDR (XLU), shown in that order below.
Alone, any of these charts could be dismissed as an anomaly. But together, they paint a picture of a market that could be gradually losing momentum:
The soft performance of these groups has had an impact on market segments that tend to have a more defensive tilt, resulting in a similar pattern of lower highs for yield-focused dividend ETFs such as iShares Select Dividend ETF (DVY) and low-volatility funds such as PowerShares S&P 500 Low Volatility Portfolio (SPLV).
Of course, while these charts bear watching, they shouldn’t be looked at in a vacuum. They simply make up the other side of investors’ current preference for the highest-risk segments of the market. These defensive groups may be out of favor, but they’re balanced by the outperformance of riskier and more economically sensitive sectors. For now, that has allowed the uptrends in the major indices to remain intact.
So the good news is that there’s nothing to worry about — yet. However, the broad indices are moving closer to the point where they could slip below their one-year trendlines on only a modest downturn.
Take the Vanguard Total Stock Market ETF (VTI), for example, which tracks the entire U.S. market and not just a specific market-cap range. At its Tuesday close of $88.41, VTI stood just 2.6% above its trendline. This is a small margin of error that underscores the need for the 30% of the market that’s experiencing lower highs to stabilize in short order.
The segments of the market that are still in a healthy uptrend are also approaching the support levels represented by their lower trendlines. Again, this isn’t a problem if stocks keep rallying.
But these groups will begin moving closer to a potential breakdown with either a period of sideways movement or even just a few days of negative returns.
Just look at the table below, which shows the five sector ETFs that remain in an uptrend, along with the current location of their support and the amount of the downturn needed for a violation. (Health Care is omitted due to an indistinct trendline.) Keep in mind, these lower resistance lines inch higher every day, so these support points will as well.
|Sector SPDR||Ticker||Support||Tue. Close||Difference|
Upon reading this, skeptics will wonder why any of this matters. We’re still in a roaring bull market, and most indices are at or near record highs.
True enough, but it’s at the times when investors are demonstrating the strongest appetite for risk that wise traders redouble their attention to potential risk factors.
Keep an eye on the trendlines in the days and weeks ahead. They might be the best way to gain an early warning that the party’s about to end.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.
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