3 Sectors on the Verge of Breaking Down

More SPDR sectors are beginning to weigh on the S&P 500. Watch these three sectors closely

While the S&P 500 continues to rise, the sum of the parts increasingly aren’t adding up to much support anymore.

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You see, while you can stare at the day-to-day price gyrations of the S&P 500 in a vacuum, if you want to find some context, you have to look at the sectors. Which is why today, we’ll look at the state of the S&P 500’s sectors (via the SPDR ETFs) and what that projects for the coming months.

But first, we should quickly tackle a couple important points.

  • The May jobs report showed improvement in the job market, which had bullish analysts high-fiving each other … completely disrespecting the fact that jobs data tends to peak late in cyclical bull markets.
  • Those same analysts are also seeing rising bond yields as a sign of economic growth and inflation. That might be the case, but the initial volatility spike we’re seeing is a more structural issue in the bond market as it adjusts to coming off a zero-interest-rate environment. Besides, bond supply has exploded in recent years while liquidity has diminished — and corporate bond issuers, aware of this, are trying to jam more bonds through the pipeline at still-record-low rates. This is only adding to the possibility of still higher volatility, and ultimately this will trickle over to equities, which are still seeing far less volatility than any other asset class.

That brings us to the S&P 500, which while positive in 2015 has seen waning upside participation for some time. Energy, utility and material stocks topped out long ago, while the rest of the sectors are either stalling or slowly rising on weakening momentum. (Note the divergence of those sectors on the chart above.)

Now, three additional sectors look at risk of failing — and have clearly defined lines of support that you can use to define a top.

Industrials (XLI)

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The chart of the industrial sector as represented by the Industrial SPDR (XLI) fairly closely resembles that of the S&P 500 itself in that the V-shaped reversal from October 2014 gave way to another higher high in early 2015 — though one that notably came on another lower high in momentum.

In fact, upside momentum as measured by the Relative Strength Index (RSI) at the bottom of the chart in blue peaked in November 2014 and has made lower highs ever since.

The 200-day simple moving average (red line) — which for many stocks and indices is at best a decent reference line — has actually served as darn good support for the XLI since 2012, with the one exception having been last October’s lashing out. Note that once again, year-to-date, the XLI has bounced off this moving average like clockwork. The breakdown last October, however, was a first indication of what could happen when this moving average gets broken for more than just a few days (namely, volatility can burst).

The price action in 2015 has also so far taken place in a wedge formation. After the February top, a series of lower highs has formed that, coupled with the lower upside momentum, is adding further pressure on the lower end of the range and the 200-day MA.

The music doesn’t stop until XLI breaks below the 200-day, but once it happens, it will be a good sign that the broader stock market is ready to correct.

Consumer Discretionary (XLY)

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The consumer discretionary sector, while still trending higher, has also done so on waning upside momentum.

The Consumer Discretionary SPDR (XLY) has been trading in a narrow range in recent months. The XLY has well-defined support at its rising 100-day MA (blue line), which is the first line of support to watch, as a break could accelerate downside pressure.

From a more structural perspective, consumer discretionary stocks will begin to feel very heavy once the broader investment community begins to understand that the rise in interest rates in 2015 has come because of the reasons I mentioned above. As such, consumer discretionaries should give market participants a good clue as to when the broader market is ready to pull lower for what I still expect to be a 10%-15% correction in coming months.

Additionally, many go-go retail stocks fit into this sector, which is to say that emotions can quickly bubble up in this space once upside momentum finally gives way to a corrective move.

Consumer Staples (XLP)

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Lastly, the consumer staples sector as represented by the Consumer Staples SPDR (XLP), which has seen a good amount of relative weakness versus the S&P 500 as of late, looks painfully toppish.

The XLP has yet to break its 2014 support line, as well as its 200-day simple moving average (red line), which also has served as a good reference moving average.

Unlike the industrials and the consumer discretionary sector, however, the staples already have given investors better signals that the January highs were it for the time being, and wouldn’t be revisited until a better correction took hold.

In the first week of June, the XLP broke below its wedging pattern from 2015 and thus is pushing much more weight onto the 200-day MA and the support line. Additionally, some of the larger consumer staples tend to have decent dividend yields (at least considering low bond yields of late) and thus have been used as bond proxies by some investors.

But with bond prices falling and bond yields rising, those consumer staples dividends will start to look a lot less interesting, and thus could lead to weakness in the sector.

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Download Serge’s trading plan in the Essence of Swing Trading e-book here. As of this writing, he did not hold a position in any of the aforementioned securities.

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