U.S. stocks closed higher again last week, the second of trading for 2018 (nothing new here). While we want to continue respecting the trends higher, it does not mean we have to pay any price for stock. Active investors through the lens of sound risk management know to “take some off,” i.e. reduce risk at the top end of trading ranges and add back to risk positions at the lower end of risk ranges.
Earnings season for the fourth quarter of 2017 kicked off last week and will get busier over the next three weeks. From where I sit, the risk here is that earnings reports, regardless of how goods could in the aggregate lead to some “sell the news” reactions on the part of traders and investors.
In other words, active investors will likely find better entry points for stocks as a whole once the market cools off a little in coming weeks.
For some visual aid around all of this I plotted a multiyear weekly chart of U.S. stocks as measured by the SPDR S&P 500 ETF Trust (NYSEARCA:SPY). Although U.S. stock by simple momentum analysis have flashed overbought readings since December, the severity of overbought readings has increased notably over the past two weeks.
Moving averages legend: red – 200 week, blue – 100 week, yellow – 50 week
Note that the weekly MACD momentum indicator at the bottom of the chart is in record overbought territory and that the price of the SPY ETF has overshot the multiyear up-trend line.
To be clear, none of this has to mean that stocks are going to immediately crash from here. Rather, a more sound way of looking at it in my eye is that reward to risk for new long positions has notably diminished for the near-term.
One opportunity I am looking at this week with my clubhouse members and mentoring students is to take advantage of a notable divergence between two sectors; the industrial sector as represented by the Industrial Select Sector SPDR Fund (NYSEARCA: XLI) and the utilities sector as represented by the Utilities SPDR (ETF) (NYSEARCA: XLU). The XLU ETF has been dropping sharply since last November while the XLI etf has done exactly the opposite. While there are plenty of sound reasons for the divergence, my bet here is that the XLI is getting near-term overbought while the XLU is nearing oversold. In a so called pairs trade one could now buy the XLU ETF and sell or short the XLI ETF, betting on a mean-reversion move between the two sectors.
In other words, even at all-time highs for the stock market there are still plenty of juicy opportunities with good reward to risk, as long as one has a sound and repeatable process for analyzing the markets.
In summary, stocks are near-term overbought and active investors would be wise to take partial profits through the lens of sound risk management. At the same time the aforementioned divergences between the industrial and utilities sectors provides opportunity.
Check out Serge’s Trade of the Day for Jan. 16.
Today’s Trading Landscape
To see a list of the companies reporting earnings today, click here.
For a list of this week’s economic reports due out, click here.
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