I’m not ready to be bullish on the general market, but I will tell you where to find pockets of bullish strength in this possible correction recovery.
Before I tell you where the bullish strength is, let me say that, while I’ve seen quite a few leading (as opposed to lagging) indications that we could be reversing back up, the fact of the matter is that the big rally we saw on Thursday was on very light volume.
My personal style is one where I need to see confirmation of reversals higher. But why should I only help people who have the same trading preferences as me?
If you’re someone who plays the market more aggressively by getting in during what appears to be the early stages of a reversal (which is an approach that leaves you that much more prone to trading false signals that were never confirmed), you will want to focus on the sectors that have reversed their supply/demand relationship back to demand before most other sectors have. You will also want to be in sectors that have already seen a ton of selling (where much of the stock for sale has already been sold to buyers). Those sectors have the highest likelihood of showing the most strength in an advancing market, or the least weakness in a declining market, in the coming months.
Among the most oversold are several of the commodity sectors, and many have recently seen significantly more constituents with new buy signals than sell signals.
Three sectors that have been oversold but are now showing demand in control are:
1. Non-ferrous Metals
On May 25, the non-ferrous metals (e.g., aluminum, brass, bronze, copper, titanium, zinc) sector had 78.7% of its constituents on sell signals (only 21.3% on buy signals), but as of now, only 67.2% are on sell signals (while 31.8% are on buy signals). That means there was a net change of 11.5% moving from sell to buy signals.
2. Oil and Coal
On May 25, this sector had 81.2% of its constituents on sell signals (only 18.8% on buy signals), but as of now only 73% are on sell signals (while 27% are on buy signals). So there was a net change of 8.2% moving from sell to buy signals.
3. Steel and Iron
On May 25, this sector had 86.6% of its constituents on sell signals (only 13.4% on buy signals), but as of now only 73.9% are on sell signals (while 26.1% are on buy signals). That means there was a net change of 12.7% moving from sell to buy signals.
But keep in mind that the steel sector has few constituents, so its sector Bullish Percent Index tends to move way up (near 100%) and way down (near 0%). Nonetheless, the sector has been whacked and is now showing demand.
Other Sectors to Watch
Again, I personally need more confirmation from the general market before getting net bullish in my portfolio, but whether you want bullish exposure to hedge yourself or are a straight-up intermediate early bull, you want to be in sectors that are in demand after already being heavily sold.
Other commodity sectors are oversold without yet showing strong demand, but, of course, that can change on a dime. Those sectors include “energy other,” which is alternative energy and oil service. When they show demand again (which they are not too far from showing), they are sectors that will have already been “washed out” (oversold).
Precious metals is the one commodity based sector that is not quite oversold and not showing demand taking back control. I don’t know what that says about the price of the yellow metal itself. Most commodities have taken a beating recently on lower demand forecast in the eurozone, a strong U.S. dollar (which has an inverse effect on commodity prices), and speculation of lower demand coming out of China. But that doesn’t mean commodity stocks aren’t in demand.
You might have heard about the idea that China is still showing huge demand for commodities even though some analysts have attributed the declining prices in the actual commodities (as opposed to commodity stocks) to lower Chinese demand.
Now analysts are saying that they suspect, while China isn’t buying as much in the open market, demand is still very strong. They say the lack of Chinese buying pressure is due to the idea that they have been tapping reserves, and their reserves are deep. Why buy commodities in the open market if they think prices will come down? Just tap the reserves and start buying again when prices pull back.
Even though commodity prices are going lower, many commodity-based stocks are moving higher. If you’re going to play the pockets of bullish strength in this recently supply-driven market, be sure to discriminate on which commodity sectors you trade. For instance, I don’t think it makes sense to get bullish on commodity funds that include both non-ferrous metals and oil service, as oil service has not yet given the green light.
Although I’ve focused today mainly on some of the commodity sectors, the non-commodity sectors that are oversold and showing demand include:
- Forest products
- Chemicals
- Machinery tools
- Textiles apparel
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