A roller-coaster ride for the markets

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 October. The market movements in the past few months altogether have been nothing short of spectacular all across the board, as we’ve seen substantial continued gains on all major US indices, pushing the overall stock market to all-time highs. Furthermore, we saw some volatile price declines in the beginning of September, which was more than expected as nothing could go up or down in a straight line forever. The positive fundamental factors that have played a crucial role in the last two month’s price action have been associated with the continued monetary and fiscal support by the Federal Reserve and the US government; the slow but continued decline in the number of new COVID-19 cases per day throughout July and August; the strong and generally better-than-expected economic reports that have been released in the last couple months (NFP, Unemployment Rate, Average Hourly Earnings etc.). However, recently we have started seeing the development of certain negative fundamental factors – a surge of the new cases of COVID-19 infections globally; failure for Republicans and Democrats to reach a consensus on the 2nd round of stimulus; President Trump’s positive COVID-19 test; heated and aggressive presidential debates; dynamic preliminary polls – that have significantly increased the overall levels of uncertainty in the market.

All of the positive catalysts have created an environment filled with general optimism and positivism among retail traders regarding the future of the stock-market.

However, retail traders tend to spend more time looking at the reasons why stocks should continue to go higher, rather than actually realizing what is the current economic, political and Geo-political situation globally. It is also important to note that due to the low to no commissions, the volatile price swings and people’s longstanding desire to make money quickly now retail traders account roughly for 25% of the stock market. Just as a reference, throughout the whole 2019 the retail traders in the US accounted for less than 10% of the overall trading in the stock market. This is as equally good for the markets and the economy, as it is a worrying signal for the reliability of the movements that we observe every day. While some retail traders are generating consistent returns from the market, a large percentage of the retail trading force out there is relying way too much on things like speculation, hype, fear of missing out etc., which in turn leads to wild swings in their performance. Furthermore, now when they represent such a large percentage of the trading done in the market that could lead to wild price swings on some of the assets out there as well. This is one of the main reasons why we want our followers to exercise extreme caution when deciding what to buy and sell in the market at the moment. Don’t let emotions and the crowd-like mentality to influence your investment behavior. Always trust the numbers, the ratios and the technical and fundamental signals that you get from the market.

Our performance so far this year

Today’s analysis will focus on the strong positive 10-year correlation between the Communication Services Select Sector SPDR Fund (XLC) and the Technology Select Sector SPDR Fund (XLK) and, which currently stands at 90%. As you know, the Dow Experts have developed a modern-market approach, based on the Dow Theory, 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 in the market, such as Technology, Services, Consumer discretionary and non-discretionary, Financials, Energy and others. Furthermore, our modern approach focuses on the usage of both fundamental and technical analysis because we believe that the combination of these two ways of analyzing the market into one rational analysis approach is vital for one’s success and profitability in the market nowadays. The correlation-confirmation model we have developed allows us to identify market reversals, as well as trend continuation patterns. Following the Dow Theory 2.0 we are able to issue specific high-probability trading setups, which in turn could help our followers to benefit from both bullish and bearish markets.


Throughout the last few months our analyses have helped hundreds of our followers to be better equipped for tackling the unprecedented market environment and volatility that we have experienced recently. Our innovative approach delivers highly qualitative market analyses by looking across 30+ correlations, multiple different sectors, industries and asset classes which enables us to have a multi-layered confirmation on the next direction for the market.

This is the reason why we were able to spot the broad-based market weakness at the end of February and recommended for our followers to be cautiously bearish and further gave them strategies to protect their capital from the upcoming downturn. Subsequently, in late March we were also able to identify that the market had already extended far too much to the downside and that a strong rebound was to be expected in April. In both of these scenarios, the new and innovative Dow Theory 2.0 not only protected our followers, but also allowed them to generate outstanding returns as well. Every single one of our Stock-picks for April reached its respective take profit levels that we laid out in our analyses, thus marking an outstanding appreciation of 25% on average in the first 4-6 weeks and has continued to further appreciated ever since! Our stock-picks for May and June also reached their initial and secondary take profit levels, thus also generating 25% return on average with a 4-8 weeks holding period.

As usual, you can find a summary of the returns that our Stock-picks for last month (September) have generated so far:

FB bought @ $247 – 7% return for 3 weeks
NFLX bought @ $475 – 13.5% return for 3 weeks

ATVI bought @ $77 – 7% return for 3 weeks

GOOGL bought @ $1,470 – 7% return for 3 weeks

CRM bought @ $240 – 12% return for 3 weeks

NKE bought @ $110 – 19% return for 3 weeks

ADBE bought @ $468 – 10% return for 3 weeks

SBUX bought @ $82.50 – 10.30% return for 3 weeks

PEP bought @ $132 – 8.3% return for 3 weeks

BAC bought @ $23 – 11.7% return for 3 weeks

AAPL bought @ $110 – 10% return for 3 weeks

DAL bought @ $28.50 – 15% return for 3 weeks

If you take a second and think about the fact that having a $20-40 subscription with DowExperts could have generated you a 10-25% return on your investment (ROI) on multiple occasions throughout the last few months, 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!

Looking Ahead

Now let’s look ahead and see what the Dow Theory 2.0 has in store for us for the month of October and how we could further optimize our investment portfolios moving forward in order to reduce our risk-exposure and maximize our profitability in these uncertain times. 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, if you want to be well diversified.

Ray Dalio, the CEO and founder of Bridgewater Associates, or in other words the largest hedge fund in the world says that diversification as a concept is probably one of the most valuable and important things that you need to pay attention to as an investor. The main reason for that is that if you really know how to minimize your overall risk exposure and allocate your capital with the proper tools and percentages in the right markets, then you could put yourself in a situation of almost guaranteed success.

The two 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 this would give us a great indication as to what is the current underlying stability and strength in the market. It is important to note that some of the largest companies in the Communication Services sector like Facebook, Alphabet, Netflix, Activision Blizzard etc. have been among the biggest winners in terms of individual stock gains so far this year. At the same time, the XLK has been the most attractive ETF out there, attracting the largest capital inflows throughout the last few months. However, also lets not forget that these companies with their respective products and services were very well positioned to benefit from the newly established stay-at-home economy. Thus, the gains in their respective stock prices have been backed up by solid company performance numbers and favorable business trends. However, as their stocks continue to set new highs every other day, their valuation metrics also change and the main question that we need to find the answer to is: “How far could these stocks go?”. Thus, we would like to look closer at the broader market as well as this particular sector and use our confirmation correlation approach in order to build our capital allocation program for October. Furthermore, we believe that by investigating more closely the broader market and both the Communication Services Select Sector and the Technology Select Sector we would be able to clarify if the remarkable gains that we have seen in the last few months are sustainable or if this was just another overenthusiastic and emotional move that is about to collapse very soon. Always remember, that the fact that a certain stock, industry or a sector has experienced strong gains and momentum, is not a definitive characteristic of successful business operations, and long-term financial success for the underlying companies.

We will first analyze the broader economic and fundamental developments in the last month in order to evaluate what is the most likely scenario for the market for the month of October. The market environment has continued to change on a daily basis in the last few weeks with hundreds of political, economic, Geo-political, public health updates being released throughout the week. The hottest topics that have affected the market the most have been monetary and fiscal stimulus measures, medical innovations and improvements, general economic data readings, US Presidential elections preliminary polls. Analyzing all of these details closely 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

We at DowExperts believed that after seeing the crazy and unparalleled roller-coaster ride that the markets went through in the March-April period, that there would be some type of consolidation and a sideways price in the months that followed. This would have ultimately allowed investors to reposition themselves in an efficient manner for the long-term, by buying into every meaningful dip. However, with the exception of couple intraday declines including the larger 7-8% drop in the beginning of September, the last few months have seen the market continuously going higher as investors have been piling up on the long equity market exposure mainly from fear of missing out on the trend. This very same mentality has allowed the market to quickly recover from the strong selloff earlier in the Fall and set new all-time highs. The thing that really worries us is that it seems that investors are 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 almost 33. From a valuation perspective this puts the current stock-market valuation in the Top 15% 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 very important for intelligent investors to always keep track of how expensive the market actually is in relation to historical averages and recognize what are the drivers for the market to be cheaper or more expensive now than before. However, this is easier said than done and usually only professionals are able to look at the market and apply an objective evaluation of the situation, while most of the retail traders and beginner investors prefer to focus on things like hype, emotion, momentum, greed, fear rather than focusing on actual economic and financial data.

So, isn’t it crazy to think that during the full-blown global economic shutdown created by COVID-19 while tens of millions of people have lost their jobs and the unemployment rate in the US initially climbed to levels not seen since the Great Depression (1929), the US equity markets have not only rallied in a completely astonishing way with more than 60% off their lows, but are also now much more expensive than they were back in January. Just to remind everyone that the US economy was in a tremendous shape before COVID-19 as we were seeing consistent 200K+ jobs created every single month, high productivity levels, GDP growth and the lowest unemployment levels in history. You don’t have to be a financial guru or an economic expert to identify that this doesn’t sound right and the logical question then would be, so where does this positivism in the stock market come from. The answer to this question is a combination between an aggressive monetary and fiscal stimulus by the Federal Reserve and the government and people’s greed and desire to get rich quick.

The Fed

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 buy 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.

Fiscal help – CARES Act, Heroes Act

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 May. However, the Heroes Act faced strong opposition by the Republicans, which stopped it from further advancing in its original form. The major focus of the initial bill was 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 aimed to include 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 was also $3.6 billion for elections, $10 billion for the Supplemental Nutrition Assistance Program and $10 billion for small businesses. After series of debates and fights in Senate regarding the sizing of the new stimulus package the House Speaker Nancy Pelosi said the newly updated bill reflects a package that’s $1.2 trillion less than the Democrats’ original HEROES Act in May, which failed to advance amid opposition from Republicans. The new bill is called the updated HEROES Act (which stands for Health and Economic Recovery Omnibus Emergency Solutions).

The new bill would also restore $600 in extra weekly jobless benefits, which until expiring in July provided a lifeline to tens of millions of adults who lost their jobs when the pandemic crippled the economy in March. The House passed the bill in September, but in the beginning of October, the odds of a stimulus package passing before the November 3 election became slimmer after President Donald Trump called off negotiations. “I am rejecting their request,” he said on Twitter, referring to the Democrats’ stimulus proposal. Mr. Trump later tweeted that he would be open to approving “standalone” funding for stimulus checks, as well as a few other measures, including aid for the airline industry.

Prior to Mr. Trump’s negotiation flip-flop, the Democrats and the Trump administration had been in talks about the bill’s funding priorities, although they were far apart on issues including support for state and local governments. Senate Majority Leader Mitch McConnell has indicated that he would not support any legislation that cost more than $2 trillion.

The most important thing here is that even if the bill fails to progress, the legislation will most likely become the basis for another stimulus round if Democratic presidential nominee Joe Biden wins the White House and Democrats gain control of the Senate. The current polls are showing that Biden’s lead is increasing by the day, and it seems that the Democrats are getting ready for a clean sweep.

The result – False optimism, greed and the fear of missing out (FOMO) led to a highly overbought and overvalued market

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 that neither of them is able to create real economic growth and activity by simply pouring endless amounts of capital into the economy. Although the unemployment rate has declined to 7.9% in September from a high of 14.7% in April, more than 21 million workers remain jobless or out of the workforce because of the pandemic, according to an estimate from the Economic Policy Institute. Thus, 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 at least 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 realize that the main drivers of this historic rally throughout the last 6 months 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 “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 October than where it was trading at the end of September.

Technical Analysis & Correlations

XLC

By looking at the daily chart, we can see the strong bullish rally that has occurred in the last 6 months has taken the price from the March 23rd lows of around $40 to the $65 all-time highs in the beginning of September. This represented an astonishing 65% gain for the ETF in such a short period of time for the market. However, right after these levels were reached, the price started a strong corrective downward movement, which ended up sending the ETF down with over 9.3%. The ETF is currently sitting at the $61-62 region after rebounding from the dynamic 50 DMA support, which is also just couple points above the important horizontal support trendline around the 57.50 level. This correction was anticipated as nothing can go up or down in a straight line forever and after the strong bullish rally in the past 6 months it was now more than normal for us to see this downward corrective movement. While we believe that the stock market in the US is currently holding a lot of intrinsic risks – COVID-19, the upcoming presidential elections, the economic recovery etc. – and that we could be in for a sideways and choppy price action in the coming months, we see that the winners would most likely continue to win. We remain cautiously bullish on the XLC ETF and believe that all these profit-taking corrections are giving us great opportunities to buy the this strong performing ETF and some of the stocks in it at a good discount, which would in turn give us a chance to maximize our profits to the upside. Moreover, some of the technical indicators that we are monitoring closely (50 DMA, 100 DMA, Bollinger Bands, RSI etc.) are currently showing a strong positive momentum of the recent up move and are signaling that the uptrend might be continuing higher. However, it is important to note that the fact that the XLC has successfully bounced from the 20 DMA, 50 DMA and the $57.50 horizontal support levels doesn’t guarantee that the price will indeed have the strength to push to new highs. Acknowledging the fact that we are once again approaching the all-time high levels in a time filled with plenty of uncertainty and high volatility, we would consider waiting for a minor 5-7% correction before we jump back in on the long side. Thus, we are not advising our followers to go ahead and start buying the stock of the ETF right now so close to its all-time highs, but to rather wait for a better entry point that we believe will present itself in the coming days and weeks.

We will start buying aggressively at the key support mark at $58 where lots of buying pressure is expected. In case the price breaks the support and drops further, we will be looking to buy more of the XLC at the next key support level at $52 where further buying activity is expected to take place and the price is likely to reverse back to the upside from either of these two levels. Our first profit target is set at $65, followed by the next target at $70-$72 where we will be fully cashing in our profits.

XLK

By looking at the daily chart, we can see the strong bullish rally that has occurred in the last 6 months taking the price from the March 17th lows of around $69 to the $127 all-time highs in the beginning of September. Since then, we have seen a volatile correction that has taken the price down with over 11% in less than 2 weeks, but XLK has quickly recovered some of the lost ground. The ETF is currently sitting at the $123 mark after rebounding from the strong dynamic 50 DMA trendline support at $112.50, which also overlaps with another strong horizontal support around the 110 level. This correction was anticipated as nothing can go up or down in a straight line forever and after the strong bullish rally in the past 5 months it was now more than normal for us to see this downward corrective movement. While we believe that the stock market in the US is currently holding a lot of intrinsic risks – COVID-19, the upcoming presidential elections, the economic recovery etc. – and that we could be in for a sideways and choppy price action in the coming months, we see that the winners would most likely continue to win. We remain cautiously bullish on the XLK ETF and believe that any profit-taking corrections would be giving us a great opportunity to buy the best-performing ETF and some of the stocks in it at a good discount. This in turn would give us a chance to maximize our profits to the upside. Furthermore, some of the technical indicators that we are monitoring closely (50 DMA, 100 DMA, Bollinger Bands, RSI etc.) are currently showing strong upside momentum, which could be signaling that the uptrend might have already resumed.

We will start buying aggressively at the key support mark at $108 where lots of buying pressure is expected. In case the price breaks the support and drops further, we will be looking to buy more of the XLK at the next key support level at $103 where further buying activity is expected to take place and the price is likely to reverse back to the upside from either of these two levels. Our first profit target is set at $130, followed by the next target at $142 where we will be fully cashing in our profits.

The daily chart shows that the price is currently approaching the former all-time highs and will most likely testing the $130 key psychological and horizontal resistance level. Considering the fact that we have seen rather strong volumes in the last few trading sessions, and that both of the above-analyzed ETFs have confirmed the current short-term bullish momentum, we could expect the price to push higher and challenge the highs. However, a 2nd failure to move beyond $130 constitute a steeper decline towards the next major horizontal support line at $110, which also coincides perfectly with the 100 DMA. We expect to see lots of buying pressure around these levels, thus sending the price back to the all-time highs around $127.

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 XLC and XLK that have a big impact on the overall performance of the two ETFs.

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


Sincerely,

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