Many investors watch the headlines like hawks, but moves in the market aren’t as dependent on those as many people think. More often, stock market moves are due either to noise or to how markets react when they reach important levels. And considering those, Amazon (NASDAQ:AMZN) and these six SPDR ETFs are telling me that the rally is over for now.
For an example of noise, suppose a person deposits money into a mutual fund at the same time that another person withdraws twice as much. The traders at this mutual fund will now need buy stocks to invest the deposit. At the same time, they will need to sell twice as many shares of the same stocks to raise the funds for the withdrawal. This will cause the prices to go lower. This happens thousands of times across the world every hour of every day. You can understand how it could move the markets.
Then there’s the reaction the various sectors have when they get to important levels. For example, I think this rally is over for now because most of the economic sectors that make up the S&P 500 are at or just under resistance.
In addition, the consumer discretionary sector has been one of the leaders of the recent rally and it is losing momentum. AMZN is the largest component of this sector and it is overbought and at resistance.
First, we will look at some sectors and you will see what I mean. Then we’ll go over levels in Amazon stock. And lastly, we will look at the SPY.
Industrial Sector SPDR (XLI)
The Industrial Sector SPDR (NYSE:XLI) is testing resistance at the $78.50 level. You don’t need to be a Market Guru or a Master Trader to see that this level is important. It was resistance at the end of April and in early May.
According to academics and random-walk believers, support and resistance levels shouldn’t exist. After all, how can a basket of dozens of stocks have the same exact valuations at two very different points in time?
But support and resistance levels obviously exist. You do not need to have a PHD to see them.
Financial Sector SPDR (XLF)
The Financial Sector SPDR (NYSE:XLF) is testing resistance around the $28 level. This level was resistance in April.
During last August and September, the financial sector did not participate in the rally. That was one of the key signals that the market was nearing a major top.
This shows why it is important to examine the undercurrents in the markets in order to really understand how to profit. Last summer the media was going crazy over the bull market, just like now. There was talk of melt-ups and amazing new records. However, savvy investors saw the underlying weakness in the financials and knew that this was a signal that the rally was about to end.
Health Care Sector SPDR (XLV)
The Health Care Sector SPDR (NYSE:XLV) has been consolidating around resistance at the $93 level and it may be starting to trend lower. The $93 level was resistance in February as well. One of the main reasons for this is that Johnson and Johnson (NYSE:JNJ) is 10% of this sector and some analysts think the company is facing some significant headwinds.
JNJ just reported earnings that were better than analysts expected, and yet the stock price still dropped. This is probably because JNJ is being sued for its role in the opioid crisis, and investors are worried about the outcome. It is also being sued for allegedly selling dangerous talcum power for babies.
I am not a lawyer and won’t guess what the ultimate outcome of these lawsuits will be. What I do know is that even if JNJ stock is innocent of these accusations, it will still incur significant legal costs and damage to its reputation.
Utilities Sector SPDR (XLU)
The Utilities Sector SPDR (NYSE:XLU) has been testing resistance around the $28 level over the past month. This sector typically pays higher dividends than most others. Because of this, there has been more interest than usual in this sector due to the action of the yield curve.
The yield curve illustrates the yield on bonds of all different durations. The vast majority of the time, the longer the term of the bond, the higher the rate of interest that it will pay. This is simply because the longer the timeframe, the greater the odds are that the bond will default. In order to take on this extra risk, investors need a higher return.
When the yield curve inverts, it means that shorter-term rates are actually higher than long-term rates. This is typically an indication that traders are bearish on the economy. They do not want to hold short-term bonds. They sell, and this drives down the price and makes the interest rates go up. Then they buy long-term bonds and makes the price rise and the yield fall.
Consumer Discretionary Sector SPDR (XLY)
The Consumer Discretionary Sector SPDR (NYSE:XLY) has been one of the leaders of the recent rally. However, the sector is now very overbought. The last time it was this overbought was in April, and a large move lower followed. A big part of the reason for this is AMZN stock. Amazon is about 20% of this sector, and it is at resistance.
If the XLY heads lower, there will probably be support around the $121 level. This because this level was resistance in April and June.
What does the term “overbought” mean? It is a measure of a stock’s momentum, looking at where the price is now versus where it was X days ago. When stocks reach extremes of this measurement, traders refer to it as overbought or oversold.
For example, according to statistics, 95% of all trading should be within two standard deviations of the average. If a stock is trading more than two standard deviations above or below the average, it would be considered overbought or oversold. It will most likely revert back to its average.
Amazon is overbought and testing resistance. The last two times AMZN stock was this overbought were in September and May. A large selloff followed both times. In addition, it is testing resistance around the $2020 level. There is resistance at this level because it was the top and an all-time high last September. Stocks frequently run into resistance when they get to levels that were prior tops.
There is also excessive bullish sentiment on AMZN. Currently, 47 Wall Street firms follow it and every single one has a buy rating on it. Excessive bullish sentiment is actually a bearish indication. This is because if everyone likes the stock, everyone has bought it. Now there are no buyers left and the only way it can do is lower.
S&P 500 SPDR (SPY)
The S&P 500 SPDR (NYSEARCA:SPY) is also overbought. If it heads lower, there will probably be support around the $294 level because it was a resistance level in April. Why do resistance levels become support levels? Consider the following.
After hitting the resistance at $294 the SPY traded lower. Those who sold it are happy that they sold. Those who shorted it have a profit. But then the SPY rallied. Now those who sold it tell themselves that if the SPY comes back to $294, they will buy it back. Those who shorted it are now losing money. They tell themselves they will cover it at $294 and break even.
Those who bought it at $294 are happy that it went higher and tell themselves that if the SPDRs come back they will buy more. Add to that the professional traders who see a clear level and want to profit from it, and now we have 4 groups of investors who want to buy the SPYs at $294.
As of this writing, Mark Putrino did not hold a position in any of the aforementioned securities.