The bullish rally is back. Does it offer attractive buying opportunities?

Overall market situation

After a massive rally on the stock market for 14 consecutive months between March 2020 and May 2021, the leading indices and stocks in the US faced some profit-taking interest that led to a short-term correction in the beginning of May. Well, such a profit-taking correction was quite widely expected and logical after most of the biggest stocks out there more than doubled in value and market participants made huge profits to the upside in a relatively short period of time.

Moreover, the Consumer Price Index (CPI) report that came out recently showed that the inflation in the US has increased by 4.2% on a yearly basis in April. In other words, the inflation has accelerated at its fastest pace in more than 12 years since 2008 as the economy has started recovering and energy prices jumped significantly. In other words, the huge increase in the annual CPI rate was the fastest since September 2008, while the monthly increase in core inflation was the largest since 1981. The core CPI report that excludes the volatile food and energy prices came out at 3% in April (year on year).

Actually, is important to mention that the huge increase in inflation compared to April 2020 was due to the fact that inflation last year was very low because of the Covid pandemic that caused a widespread shutdown of the US economy.

The Federal Reserve policymakers as well as many other economists are claiming inflation would settle down later in the year around the 2% mark targeted by the central bank.

Due to the high inflation rate investors started worrying about a potential interest rate hike in the US that could have a negative impact on the stock market. Yet, in order to calm the markets, Fed officials have repeatedly said they would not raise interest rates or pull back on monthly bond purchases until inflation averages around 2% over a longer period of time.

By saying so, the Federal Reserve officials calmed the market and the correction that took place recently has been seen as a great buying opportunity at a discount, which has led to more bullish rallies to the upside since the 12th of May.

Today’s analysis will focus on the 10-year positive correlation between the SPDR S&P 500 ETF Trust (SPY) and the Materials Select Sector SPDR Fund (XLB), which stands at 85%.

We would also be looking at some of the biggest companies within the two ETFs and evaluate their recent performance, which would give us a chance to come up with some potential investment ideas and be able to maximize our followers’ profitability in the current market environment.

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. Moreover, our modern approach includes the importance of both fundamental and technical analyses because we believe using a combination of both is vital for one’s success and profitability on the market nowadays. The correlation-confirmation model we have developed gives us a chance to identify market reversals, as well as trend continuation patterns, which in turn give us specific buying or selling signals, giving us a chance to benefit from both bullish and bearish markets.

The SPDR S&P 500 ETF (SPY) tracks a market-cap-weighted index of US large and mid-cap stocks and is the best recognized and oldest ETF and typically tops ranking for largest assets under management (AUM). As a matter of fact, the SPY has got $360 billion in assets under management. The SPY is also the ETF with the greatest trading volume with its daily average of $27 billion. Moreover, the SPY is very well diversified thanks to its investments in different sectors on the market. Its biggest holdings are Microsoft Corp., Apple Inc.,, Facebook Inc., Alphabet (Google), Berkshire Hathaway, Inc., JPMorgan Chase Inc. & Visa Inc.

The SPY is actually the largest and most well-known ETF and offers a great exposure to the largest companies in the US, following the largest Index in the US – S&P 500, which gives investors a chance to benefit from the day-to-day fluctuations on the leading 500 companies in the US and benefit from their share price movements.

As a matter of fact, the Q1 financial results were quite impressive, especially considering the fact that the economy has been in a slowdown caused by the Covid-19 pandemic in 2020.

In other words, the leading US companies have reported strong financial results and an earnings beat, topping up analysts’ expectations, which is among the main reasons why the stock market has continued its strong uptrend for so long even during the pandemic.

As we have mentioned in many previous analyses, the Federal Reserve is a key player on the market and we believe our followers should always follow the FED’s monetary policy as it gives lots of insight as to what the central bank is expected to do with interest rates and other monetary policy tools in the future. That by itself leads the market and is among the most important factors that should be followed at all times.

Going back to our previous point, the FED has reported that the recent CPI report wouldn’t change their plan towards interest rates and that calmed the market. In fact, they are expected to give more time for the economy to go back to normal levels and the inflation to stay at around 2% for longer before raising interest rates. When interest rates rise it becomes more expensive for companies and individuals to borrow money from the banks and finance their operations. Yet, the FED is expected to start gradually raising rates most likely at the end of this year or at some point next year. Such a gradual raise wouldn’t hurt the companies’ performance so much and the stock market could still keep its strong uptrend afterwards.

Technical analysis

By looking at the daily chart of the SPY, one could see the massive uptrend that has been taking place since March 2020. In fact, the SPY bottomed out from the $218 lows back then to reach the $422 highs on the 7th of May this year (94%). In other words, the SPY has almost doubled its value in only 14 months. As we mentioned above, the leading companies out there reported strong results for the Q4 of 2020, as well as the Q1 of 2021, proving their strong presence on the market and positioning even during the pandemic.

The daily chart shows that the price faced lots of selling pressure at that $422 mark and that led to a short-term profit-taking correction towards the $405 mark. Yet, the price then formed a double bottom at that point right above the $400 support, which was seen as a strong bullish signal that motivated lots of traders and investors to start buying again at a discount and follow the strong bullish rally on the price.

Currently, the price is testing the $420-$422 where the upper Bollinger band matches with the resistance at that point and the Stochastics indicator has already gone up close to the overbought territory. In other words, we would like to follow the strong uptrend on the price but would rather prefer to wait for a short-term pullback on the SPY that would give us a chance to buy it close to the first support at around $405 where the price bounced from in the middle of May. In fact, we are expecting to see lots of buying pressure again around that level. In case the price breaks the first key support at $400-$405, we would expect to see more buying interest around the next strong support at $395 and the price is likely to bounce back up from one of those key support marks.

In order to decide whether buying the SPY at around the levels we mentioned above would be a reasonable idea, we would analyze the recent performance of the other ETF we are analyzing – the XLB, for a further confirmation for our bullish stance on the SPY.

The Materials Select Sector SPDR Fund (XLB) tracks a market-cap-weighted index of US basic materials companies. The XLB invests in basic materials companies from the S&P 500. These would include companies in the chemicals, paper and forest products, metal and mining, containers and packaging, and construction materials industry. In fact, XLB favours large-cap companies and rebalances its portfolio on a quarterly basis.

The XLB has got almost $10 billion in assets under management (AUM) and an average daily trading volume of $550 million.

As a matter of fact, the materials sector is currently been boosted by a higher demand, supported by the improvement of the US economy as the situation with the virus is getting better, more people are getting vaccinated and the country is getting out of the tough pandemic times we saw last year. Thus, the business activity has been boosted and the construction sector has started operating more actively and efficiently, supporting those companies’ financial performance.

Technical analysis – XLB

By looking at the daily chart of the XLB, one could see the massive uptrend that has taken place since March 2020. In fact, the price bounced from the lows at $38 back then to reach the $89 highs in May this year (134%). The chart clearly shows the resistance at $89 which the price is testing now and forming a double top figure, which looks almost the same as the SPY. In case of a little profit-taking correction to the downside, the price is likely to find lots of buying pressure at the first strong support at $85, followed by the next key support at $78. The lower Bollinger band matches with the first strong support at $85, while the 100-day moving average stands right at the next major support at $78, giving further bullish indications. Thus, we believe the price is likely to bounce from one of those two key support levels and will take advantage of it in order to maximize our profitability to the upside.

Chart: XLB

We would wait for a little pullback on the price and start buying the XLB at the first key support at $85. Should the price break that support and go lower, we would add more to the buy positions at the next major support at $78, which would give us a chance to get a better average price on our long positions. Our initial profit taking target would be set at $93-$95, followed by the next target at $102-$104 where we would be fully cashing in our profits.

Overall, we shall say the recent performance of the XLB clearly confirms our bullish stance on the SPY and we would be looking to add it to our portfolio.

Chart: SPY

We would wait for a correction on the price and start buying around the first strong support at $405. Should the price drop further in the short-term, we would be interested in buying more at the next key support at $395 where more buying pressure is expected. Our initial profit-taking target is set at $428-$432, followed by the next target at $446-$453 where we would be fully cashing in our profits.

In order to further assist our followers in boosting their investment results, we have analyzed the performance of some of the biggest companies within the SPY and XLB that have a big impact on the overall performance of the two ETFs.

You can find them in our Stock Picks for June rubric.


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