Are there good investment opportunities in these premium sector ETFs?

The time has come again for us at DowExperts to share with you our most recent ETF correlation analysis and overall market observation, in order to help you to prepare for what’s coming in the month of June. The market movements in the past 10 weeks altogether have been nothing short of spectacular all across the board, as we saw substantial continued gains on all major US indices, marking the strongest 2-month period for the US stock market since 1987. The fundamental factors that played a crucial role in the last two month’s price action were associated with new unprecedented monetary and fiscal stimulus measures by the Federal Reserve and the US government; with some positive developments on the medical front with new improved testing solutions and potential anti-viral treatments for COVID-19 and last but definitely not least with the official reopening of the US economy, as now all 50 states are out of the COVID-19 related lockdown.

Today’s analysis will focus on the strong positive 10-year correlation between the Communication Services Sector SPDR Fund (XLC) and the Technology Select Sector SPDR Fund (XLK), which currently stands at 90%. As you know, the Dow Experts have developed a modern-market approach, based on the Dow Theory and created by Charles Dow more than 100 years ago. Yet, while the basic Dow Theory was based purely on the correlation between the Dow Jones Industrial Average and the Dow Jones Transportation Average, our modern-market approach is based on more than 30 correlations, including all the other key sectors on the market, such as Technology, Services, Consumer discretionary and non-discretionary, Financials, Energy and others.

A lot has happened since the terrifying selloff that we saw back in March, as the overall market sentiment has turned from extremely bearish in March to strongly bullish in April and then to extremely bullish in May. It seems that the famous saying in the investment arena “Sell in May and go away” was definitely not followed by traders and investors last month, as the markets kept on rallying higher, thus almost reaching their pre-COVID highs. We at DowExperts believed that after seeing the crazy and unparalleled roller-coaster ride that the markets went through in the March-April period, the month of May would have brought a sideways price action, which would have ultimately allowed investors to reposition themselves in an efficient manner for the long-term. However, investors have continued to pile up on the long equity market exposure seemingly not being worried about the fact that on average stocks are much more expensive on an earnings basis today, than they were when the market was sitting at the all-time highs back at the end of February. The Shiller 10-year P/E ratio of the S&P 500 back then was sitting at around 25, whereas today it is at 30. From a valuation perspective this puts the current stock-market valuation in the Top 20% of the most expensive markets since 1871. Furthermore, it is important to note that the Shiller 10-year P/E ratio has been a very accurate financial metric for predicting the future price movements of the S&P 500 as it shares a 99.7% positive correlation with the composite.

It is always important to look at the events of the day with a clear mind and without emotions, because by doing so you would be able to recognize that the 45% appreciation of the market in the last 2 months is unsustainable and that the market has substantially overextended to the upside. It has officially entered into a highly overbought and overvalued territory, which in turn imposes serious intrinsic risks for buying at these levels. However, a lot of investors out there are struggling to control their emotions and in many instances instead of buying low and selling high, they end up doing the exact opposite, which apart from bringing negative results is also very frustrating. This is the main reason why we at DowExperts developed our unique and innovative Dow Theory 2.0, as it provides all investors with the opportunity to approach and analyze the market in a completely objective manner. Additionally, it also allows our followers to have a clear game plan in any situation and to make their own investment decisions based on significant amounts of data including charts, graphs, correlation matrices, technical indicators, fundamental economic, political and geopolitical factors etc.

Looking back at the way we have guided our subscribers in these historic times in the market, we can proudly say that in the last 4-6 weeks we have received multiple emails from a lot of them expressing a great deal of gratitude and appreciation for our knowledge, expertise and professional market insight. Following the new, innovative and proven Dow Theory 2.0 our cross-sector correlation analyses in February and March helped our followers to not only prepare for the declines in March, but to also rise as phoenixes from the ashes of that mind-blowing market crash. To summarize briefly for our new followers, we at DowExperts spotted a broad market weakness across multiple different charts and time frames on all of the major ETFs and stocks that we were observing back in February, which resulted in us issuing a cautious to bearish outlook for the stock market. The ETF correlation analyses that the DowExperts released then allowed our clients to collect the profits on their long-term buy positions and protect their portfolios from the huge downturn that followed. Then a month later, in our analyses for March we investigated the exceptional volatility and the seemingly relentless downward pressures in the stock market, by again using our innovative and thorough Dow Theory 2.0 investment approach in order to help our followers navigate these unprecedented times. Again our analysis proved to be spot on by confirming that the downtrend had significantly overextended to the downside and that a major rebound was expected in April, which is exactly what happened.

By using our investment philosophy and expertise our followers were able to apply a rational analysis for their next steps as investors while everyone else out there was letting their emotions, mainly their panic, govern their investment behavior. Every single one of our Stock-picks for April has reached its respective take profit levels that we laid out in our analyses, thus marking an outstanding appreciation of 25% on average in the last 4-6 weeks! Our stock-picks for May have also reached their initial take profit levels, thus generating 15% return on average in the last 2-4 weeks. If you take a second and think about the fact that having a $20-40 subscription with the DowExperts could have generated you a 25% return on your investment (ROI) in less than 4 weeks, you would understand that this is an unprecedented opportunity for you as an investor to benefit from our professional and highly complex market analyses at these substantially discounted starting prices!

And let’s face it, whether you have an investment portfolio of 10,000 EUR, 100,000 EUR or 1,000,000+ EUR, a 25% return in 4 weeks represents a remarkable monetary gain for you as an investor. Don’t worry if you missed those gains last month, because you didn’t know that we are here, as now you do and your financial future is in your own hands. Let us help you fulfill your investment potential!

Now let’s look ahead and see what the Dow Theory 2.0 has in store for us for the month of June and how we could further optimize our investment portfolios moving forward in order to reduce our risk-exposure and maximize our profitability. The proper re-balancing and sector rotation is exceptionally important in such volatile market conditions, as you need to always make sure that your capital is properly allocated.

The two sector ETFs that we will be analyzing closely today are the XLC – Communication Services Select Sector SPDR Fund and the XLK – Technology Select Sector SPDR Fund, as some of the largest companies in these two respective sectors have been among the biggest winners of this unprecedented rally. Furthermore, we believe that by investigating more closely the broader sectors we would be able to clarify if the market has further room to grow, or if an inevitable decline is on the cards.


We will first take a look at the broader economic and fundamental developments in the last month in order to evaluate what is the most likely scenario for the month of June in terms of monetary and fiscal stimulus measures, medical innovations and improvements, and general economic data readings as this will have an important role in determining our overall bias for the weeks ahead. Later, we will investigate the XLC and XLK sector ETFs independently and we will see how they stack up against one another in terms of correlations, confirmations and signals. Last but not least we will recommend 2 stocks in each of the two sectors for our followers to consider taking advantage of in the coming weeks!

Economic Outlook

In times of an unprecedented broad economic shutdown caused by the COVID-19 pandemic, central banks around the world realized that the risks of a global economic depression are not only real but that they elevated by the day back in the March-April period, as every day the world stayed shut cost billions of dollars of actual realized losses for virtually every sector our there. Thus, the Federal Reserve, which is the largest and most influential central bank in the world decided to adopt an actively supportive “by all means necessary” approach basically announcing their readiness to provide an unlimited financial stimulus for the US economy in order to avoid another depression.

“We are deploying these lending powers to an unprecedented extent [and] … will continue to use these powers forcefully, proactively, and aggressively until we are confident that we are solidly on the road to recovery,” says Jerome H. Powell, Chair of the Federal Reserve Board of Governors.

They cut the benchmark interest rates to virtually zero and rolled out a series of emergency and unorthodox lending facilities designed to backstop markets and keep credit flowing to businesses. The Fed’s balance sheet has already reached $7.2 trillion, which is the largest it has ever been. One of their latest measures was to include $2.3 trillion in lending to support households, employers, financial markets, and state and local governments. Additionally, the Fed resumed its Quantitative Easing program aimed at purchasing massive amounts of securities a key tool employed during the Great Recession, when the Fed bought trillions of long-term securities. As a result of the COVID-19 outbreak both the treasury and mortgage-backed securities markets have become completely dysfunctional, and the Fed’s actions aimed to restore smooth both investors confidence and market functioning so that credit can continue to flow. The initial commitment by the Federal Reserve was to at least $500 billion in Treasury securities and $200 billion in government-guaranteed mortgage-backed securities over “the coming months.” However, the followed historic market declines and broad-based panic caused the Fed to modify its monetary policy, thus making the purchases open-ended. It also expanded purchases to include commercial mortgage-backed securities, which was another unexpected and unprecedented move, as it basically means that there is no limit as to how much the Fed is willing to inject into the economy.

The Federal Reserve also slashed the reserve requirement for banks and begun buying up commercial paper (a form of short-term corporate debt). It also started buying municipal bonds for the first time and took its first steps into certain types of riskier corporate bonds, and it’s promised to buy an unlimited amount of government debt for the duration of the crisis. It will also backstop loans from bank lenders participating in the Paycheck Protection Program.

Regardless of the powerful monetary stimulus provided by the Fed, the economy needed a government intervention on the fiscal side as well in order to stay above water in these difficult times and the US government knew that. Thus, it delivered massive liquidity packages throughout the last few months including the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and a $484 billion Coronavirus relief package aimed at helping Small Businesses survive. The latest major government fiscal initiative is called the $3 trillion Heroes Act, which was introduced by House Democrats and passed the house in the beginning of this month. The major focus of the bill is the $875 billion in additional funding for state and local governments and $20 billion each for tribal governments and U.S. territories. The new legislation also includes another $75 billion for testing, new provisions for hazard pay for essential workers, $75 billion in mortgage relief, $100 billion for rental assistance, plus another $25 billion for the Postal Service and provisions for a second round of $1,200 stimulus checks. In addition to all of that there’s also $3.6 billion for elections, $10 billion for the Supplemental Nutrition Assistance Program and $10 billion for small businesses. If it passes the Senate in its current form, the bill’s astronomical price tag would make it the largest piece of stimulus legislation in American history.

The combined and relentless approach on the monetary and fiscal side has substantially increased investors confidence that not only the Fed but also the US government are staying on top of this current crisis and are both ready to do whatever it takes to help businesses and individuals to survive this economic destabilization. This has been the major reason for the continued appreciation of the stock market in the US in the last few months. However, we at DowExperts believe that while it is tremendously important for the government and the Fed to continue to support the economy in this active manner, at the same time we have to face the fact they neither of them is able to create real economic growth and activity by simply pouring endless amounts of capital into the economy. With over 40 million people being unemployed in the US, it will take a very long time for the economy to get back to its pre-COVID levels of activity and productivity. In reality this means that all of the companies out there will see downward revisions of their revenue and earnings expectations for the next 2 quarters, which will ultimately slower their growth, lower their intrinsic value and will inevitably lead to some price declines. Let’s not forget that more than 80% of the publicly traded companies in the US officially withdrew their fiscal 2020 guidance when they delivered their Q1 earnings reports in the last couple months. This is one of the many warning signs that we at DowExperts identify and recognize as an indication that the road ahead could be much tougher than everyone expects.

When you see that the main drivers of this historic rally off the lows are strong liquidity injections by the government and the Fed; speculation about a quick economic recovery, without any real proof that this is even a realistic scenario; greed caused primarily from the fear of missing out; and the general misconception that the fact that the economy is “reopening” means that the economy is “recovering”, well you must ask yourself whether or not you believe that this is a sustainable and healthy environment for the market to continue to rally in the future as well. We at DowExperts believe that the economy is not going to fully recover until we start seeing actual consumer spending, consistent job creation, lower unemployment rate, productivity and manufacturing growth and many other economic indicators that are currently painting a very dark picture as a whole. Thus, we are issuing once again our cautious and rather bearish sentiment for the coming month, as we believe that even if the market doesn’t revisit its March 23rd lows, it will be definitely trading lower in June than where it was trading at the end of May.

XLC – XLK: Communication Services vs. Technology

Sectoral Fundamental Analysis

XLC

The XLC tracks a market-cap-weighted index of US telecommunication and media & entertainment components of the S&P 500 index and offers exposure to the Communications services sector. The fund includes all members of the former telecom sector (expanded to include internet service providers), as well as media & entertainment companies previously classified in the consumer discretionary or tech sectors. This latter industry group includes many heavyweights such as Facebook, Alphabet, Netflix, and Disney.
XLC is one of the eleven Select Sector SPDR funds, which draw their holdings from the S&P 500 index. Typically, trading volume in these products is high. The expense ratio places the fund in the middle of the competition.

The Communications service sector is part of the broader Services sector which has gained unquestionable dominance throughout the last 20 years in building economic prosperity, job creation and wealth generation. The growth of the industry has been staggering as it has become the largest industry in the US with 67% contribution to the US GDP for 2018. A recent study has shown that 4 out of every 5 private-sector jobs in the US are indeed in the Services sector. These are just some of the reasons why we spend so much time in analyzing this particular sector as we understand that the Services sector will continue to grow its influence on the US economy, which in turn is expected to create a large number of profitable investment opportunities.

XLK

On the other hand, the XLK is another extremely important ETF to follow as it represents the performance of the most attractive sector in the US economy – technology. The XLK tracks an index of S&P 500 technology stocks, including all of the big tech heavyweight names in like Apple, Microsoft, Visa, Intel, Mastercard, Cisco, Nvidia, PayPal & others. The constant innovation that these companies have been able to deliver is a key factor in their overall stock performance. When these companies are delivering new products, penetrating new markets, introducing new concepts, making meaningful acquisitions, engaging in active stock buyback programs, their respective stocks tend to go up. We also have to keep in mind that another important driver for the long-term success of these companies is attributed to the phenomenal senior management leadership in the sector altogether. With names like Tim Cook, Bill Gates, Jensen Huang (NVIDIA) and Daniel Schulman (Paypal) on the roster, this sector will continue to dominate when it comes to growth and expansion for the years to come. As a result of all of the above the leading technology stocks out there are always part of the biggest investors portfolios and are an essential component of the market.

Technical Analysis and Correlations

XLC

By looking at the daily chart of XLC we can clearly see that the price has moved strongly to the upside in the last 2 months, following the broad market historic bull-run off the March lows. The ETF has enjoyed a remarkable run from the $40 mark to the $56 level that it reached in the beginning of June, thus marking a 42.5% gain in 8 weeks! It has been able to fully recover the losses caused by the pandemic shock in March and now is re-testing its all-time highs around $57. We saw a strong rejection on the first attempt of the XLC to overtake this crucial technical level as the price was sent down sharply with almost 6% in the period June 10-12th. The Communication Services Select Sector SPDR Fund is now sitting at the $54 mark, which coincides perfectly with the diagonal upward sloping trend support. This particular diagonal trendline support has been acting as crucial floor for the price throughout this remarkable bull-run in the last 2 months and the ETF has managed to bounce off of it on 3 separate occasions so far. From that, one could make the assumption that the price could rebound from this level once again and continue to move higher. However, we at DowExperts see this volatile and sharp intraday reversal as a much more meaningful indication for the current unstable market conditions. Our main concerns are that it has occurred near the all-time highs for the ETF after a 42.5% appreciation in 8 weeks in an unstable economic environment with low productivity and high unemployment levels and generally lower revenue and earnings expectations for 90% of the companies out there. The RSI has already broken to the downside the strong uptrend that it has been moving in and it is currently trading below the 60 level, which is generally a bearish signal. Additionally, the Stochastic Oscillator has also moved sharply lower and it is currently sitting at around the 42 level, which in turn is the lowest Stochastic reading that we have seen since the lows in late March. The downward trending indicators, the strong price reversal on the chart, and the generally weak economic environment out there are all indicating that the weakness on the price chart is much more serious and meaningful than just a short-term profit taking correction and we want our followers to be aware of that. Our analysis shows that if the $54 diagonal trendline support is broken next week, then the ETF could easily continue to slide lower towards the 50% and 61.8% Fibonacci retracement levels, which are currently sitting at $48.33 and $46.34 respectively. We also see every rally up towards the all-time highs as a great short-term selling opportunity, as we believe that there is generally too much optimism already priced in the market. A stronger pullback at the moment would do nothing else but normalize and stabilize the outrageous stock-market roller coaster of the last few months and help the market to re-evaluate and re-establish its intrinsic value. We need to see the market going back to the lower volatility days of making 1-2% moves per day consistently over a longer period of time instead of these wild 5-7% intraday swings, in order for us to officially state that the worst is behind us.

Dow Theory 2.0: Correlation Confirmation

As you know, we at Dow Experts have developed a correlation confirmation model that allows us to identify, analyze and confirm different market movements, which in turn helps to improve and maximize our followers’ investment profitability. So, before we take any action on the XLC we need to make sure our short-term bearish expectations are confirmed by the other ETF we are analyzing today – the XLK, and only if we get a confirmation from it then we would proceed with selling the XLC. The Communication Services and the Technology sectors share a very strong 90% positive 10-year correlation, thus both the potential confirmation or rejection of the signal would be a reliable indication for us as to where the market is headed next.

XLK

When we take a look at the daily chart of the Technology Select Sector SPDR Fund the picture is not only similar to the one we see on the XLC chart, but it is actually even worse. The XLK was trading down around the $68 mark back at the end of March before it started its monstrous 53% bullish run that we saw in the last 2 months. The price managed not only to challenge the pre-COVID 19 all-time highs around $102-$103, but to even break them and reach a new high at the $105 level on June 10th. However, this remarkable bull run was finally affected by the law of gravity as the price was quickly rejected from these highs and the ETF dropped roughly around 7% on June 11th, thus creating a very negative and bearish picture for the month of June.

The major drop at the end of last week actually broke the upward sloping diagonal support line on the price chart, which was supporting the price of the ETF in the last 8 weeks. Again the intraday reversal was sharp, volatile and on a much higher than average volume, which indicates that it wasn’t just a short-term profit taking correction but rather a long overdue shift in investors sentiment. The RSI and the Stochastic indicators are both confirming the major weakness on the chart by also breaking their respective uptrends and moving into bearish territory.

Our analysis shows that if the middle Bollinger band currently sitting around the $97-98 level is broken next week, then the ETF could easily continue to slide lower towards the 50% and 61.8% Fibonacci retracement levels, which are currently sitting at $86.83 and $82.56 respectively. We also see every rally up towards the all-time highs as a great short-term selling opportunity, as we believe that there is generally too much optimism already priced in the market. A stronger pullback at the moment would do nothing else but normalize and stabilize the outrageous stock-market roller coaster of the last few months and help the market to re-evaluate and re-establish its intrinsic value.

We will start opening our short-term SELL positions on the XLK around the $101-103 levels in order to benefit from the expected downturn in the market in the coming weeks. We will use every rally towards the prior highs as a great opportunity to improve our average cost basis and to further optimize our profitability to the downside. We are far from the thought that the market and the XLK specifically will be re-testing its March lows, as we are long-term bulls of the US equity markets and especially of the Technology Sector. However, the Dow Theory 2.0 clearly shows that the market and these two ETFs specifically are sitting in extremely overbought conditions and that the recent strong reversal signals have come at a crucial time and at crucial levels in order to show that the underlying fundamentals are much more unstable, uncertain and generally weaker than the fundamentals we had in the beginning of the year.

As a result of our cross-sector correlation confirmation analysis we will issue a cautious short-term bearish stance on the XLC and XLK as we expect the two ETFs to experience weakness and respectively move lower in the coming weeks. However, we would like to emphasize on the fact that these short-term price declines should be treated as great long-term buying opportunities by our followers as they will allow us to buy some of the best-in-class companies and our favorite stocks at a tremendous discount. You should always salute and welcome the opportunity to buy more of the best stocks out there, when the market moves lower. These two ETFs have been some of the biggest winners for a long time now and the reason for that is associated with the fact that the companies comprising these ETFs are the companies that define and shape the world that we live in today. Thus, the XLC and XLK will continue to be Dow Experts’ most favorite long-term growth ETFs out there.

We at Dow Experts enjoy analyzing the market and helping our followers maximize their profitability by following our trading and investing ideas, which are always supported by our rational investment approach.

In order to further provide our followers with a strategy on how to fully capitalize on the above-described patterns and correlations, we analyzed the performance of some of the biggest companies within the SPY and XLY that have a big impact on the overall performance of the two ETFs.

You can subscribe to our Full Package in order to receive all of our top stock and ETF picks and analyses for the month plus new Bonus reports every month!

Sincerely,

Add a comment