Bearish reversal with a triple confirmation

Today is September 20th, 2018 and we are seeing another day of record highs on the SPDR S&P 500 ETF Trust (SPY), where the most famous and commonly traded ETF has reached and even surpassed the $293 mark. However, few things should be worrying investors at this time, as this picture-perfect

The ETF with the highest 5-year correlation to SPY is the Consumer Discretionary SPDR (XLY), with the outstanding 93% correlation. When we take a closer look at the SPY and XLY daily charts, we can see a large number of similarities, which historically have proven to be very accurate in predicting the next big move for the stocks included in both of these ETFs.

Currently both of the SPY and XLY daily charts are showing loss of the upward momentum, which could be a signal for a potential shift in the overall bullish sentiment. The price charts of both instruments have continued to make higher highs and higher lows throughout the last few trading sessions reaching all-time highs, while the Relative Strength Index (RSI) has indicated that ever since both the SPY and XLY extended into overbought territory in the beginning of this month, the momentum has been progressively fading.

This disparity is usually referred to as a Divergence, which is a strong indication for the next direction of the market, but is also rarely used as a single tool for confirming a potential trade. However, when this divergence is confluent with diagonal and horizontal trendline resistances/supports, and is also present on both of the charts part of our inter-market correlation analysis model, this further strengthens the power of the signal.

The SPDR S&P 500 ETF Trust (SPY) and Consumer Discretionary SPDR ETF (XLY) price on the daily charts above have been moving in the current upward channels since April, 2018 which in turn are defined by the upward sloping diagonal support and resistance trendlines portrayed on the charts. There have been numerous fundamental factors that have positively affected and further supported the growth of the S&P so far this year – a low interest rate environment, the lowest unemployment rate in more than a decade, a lower corporate taxation, a high economic productivity, a moderate wage increase, a stronger US Dollar etc.

However, the bullish trend has overextended in the last 7 trading days and we are seeing warning signs of a potential market reversal ahead, as well as an overall shift in investors’ sentiment. The SPY and XLY have both reached the diagonal resistances within their respective uptrends and are now both facing potential rejection and high number of sell orders from these levels, as a result of their 93% 5-year correlation. The potential weakness ahead is further confirmed by the overall loss of momentum seen in the substantial divergence between the price charts and the RSI graph that we discussed earlier.

Once a technical trading pattern is spotted on the broad S&P500 market index, the Dow Experts always turn towards their highly sophisticated and carefully calculated correlation model in order to find, which sectors are most vulnerable or respectively have the highest growth potential from this trading setup. This allows us to find the best in class publicly traded companies, with the proper weight representation within the specific ETF sector that we observe and issue a high-probability recommendation on a stock with multi-level confirmations across 3 different charts and multiple different sector ETFs.

Stock picks

The next stock-pick for the week is the largest home improvement retailer in the United States, Home Depot (HD) as it is currently the 2nd largest company by weight in the Consumer Discretionary SPDR ETF (XLY) representing 11.05% of the whole ETF. Even though that we like the stock as a long-term holding, we are seeing a high-probability for the stock to experience a short-term decline as a result of the broad marker and sector ETF weakness. The story behind the stock is indeed favorable for every long-term value investor, as its’ current cheap valuation, great dividend yield and strong market position are just some of the reasons why every intelligent investor would be proud to own Home Depot’s stock in the long term. The company offers a great and relatively cheap exposure to the Consumer Discretionary sector, while it also offers significant upside potential.

Considering the recent developments within the ETF market and the detailed analysis provided above our last stock-pick for the week is Amazon (AMZN) due to the following reasons. The stock is not just part of both of the analyzed here ETFs, but it is also one of the Top 3 stocks by weight within XLY and SPY with 22.38% (#1) and 2.90% (#3) respectively, which makes the stock extremely vulnerable to the weakness that we have spotted and confirmed for both the SPY and the XLY. As we pointed out earlier, in many instances the market proves to be irrational, by sending qualitative companies lower as a result of their participation in these highly traded ETFs, at times when those funds are vulnerable. This is a trend that is expected to continue in the future, as the ETF market has continued to grow at an annual rate of over 20% CAGR since 2005. Global ETF assets, which totaled just $417b in 2005, had reached $4.4t by the end of September 2017

*Please visit the full analysis here and find out more details regarding this trading set-up!


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