SentimenTrader ---- TradingEdge Weekly for Oct 11 - Momentum in Industrials and Utilities, improving economics, sector seasonals

 

TradingEdge Weekly for Oct 11 - Momentum in Industrials and Utilities, improving economics, sector seasonals

Key points:

• The Dow Jones Industrial Average has put in a historic performance across time frames
• Economic reports are starting to beat economists' expectations 
• There are some long-simmering warning signs on the Nasdaq
• Utilities have gone on a record-breaking run in some respects
• Factors are lining up for healthcare
• Semis are entering a positive seasonal window
• A handful of funds are entering compelling seasonal windows through year-end
• Using the dollar's trend to trade commodities

Industrials doing some heavy lifting

The Dow Utilities index has been on fire (see below). It's not just defensive stocks like utilities that have been doing well, though. 

Over the past 250 trading days, the Dow Industrials have advanced just under 61% of the time. If we stretch our time frames, the Dow has also risen a little over 60% of the time during the past 100 weeks. When we zoom out even further, the Dow has advanced in 63% of the months over the past 60 months (five years). And they've risen during 80% of the years over the past 15.

So, the venerable index shows impressive and persistent momentum on daily, weekly, monthly, and yearly time frames. The chart below shows an average of the up periods across the four time frames.

The table below shows other times when the average of up periods across time frames exceeded 66%. There were only a handful of precedents, but losses were rare. The Dow's returns were especially impressive over the following nine months.

Looked at another way, the Dow has risen at least 60% of the time during all four time periods studied. Again, this is exceptionally rare. When we combine both studies, there were almost no precedents. There were only two times in 124 years when the Dow rose at least 60% of the time across all four time frames, and its average percentage of rising periods was 66% or higher.

When the signals were triggered in 1959, the Dow continued rising for several months. But then it entered a period of wide swings that frustrated bulls and bears alike. It made no progress either way until starting a new sustained trend in 1963.

The only other period with multiple signals in a compressed time frame was 2017-18. Once again, the Dow continued to rise for months but then fell into a funk that lasted for years, finally breaking out with a sustained trend after the pandemic surge.

Positive economic expectations

The Citi Economic Surprise Index turned positive, following an extended period in negative territory. Dean showed that similar trends in economic reports surpassing expectations fueled a bullish bias in the S&P 500.

The previous streak of at least 100 consecutive days in negative territory occurred in 2019, when the Federal Reserve last shifted from a tightening to an easing policy stance, offering an interesting comparison. 

While the sample size is small, whenever the Citigroup Economic Surprise Index increased above zero following at least 100 consecutive days in negative territory, the S&P 500 rose in all but one case over the following year. 

If the threshold is reduced from 100 consecutive days to 80, the sample size grows, with precedents jumping from 6 to 12. Under these conditions, the S&P 500 continued its upward trajectory, rising 92% of the time over the subsequent year. 

Given the stronger-than-expected economic reports, it's no surprise that cyclical sectors outperform while defensive ones lag. 

A Nasdaq warning

The stock market remains constructive on a trend-following basis. However, Jay noted that some potential warning signs have recently flashed.

Bill Omaha created the Titanic Syndrome in the 1960s. It highlights a technical market condition when stocks have recently been at a high, and then there is a sudden jump in new 52-week lows versus highs on the Nasdaq. 

The chart below highlights all dates when the 150-day moving average of the Nasdaq Titanic Syndrome indicator was above 0.10.

Median returns for up to six months are positive, and the Win Rate is above 50%. However, these returns and Win Rates are below average, and the median 12-month return and Win Rate of -16.28% and 36%, respectively, is an important red flag warning to investors. A potentially more stark warning sign appears if we highlight only those dates when the 150-day moving average crossed above 0.20.

The HiLo Logic Index was created by Norman Fosback in 1979. Intended to observe "split" market conditions, it looks for times when there are both a large number of 52-week highs AND 52-week lows among securities on the exchange. When there are a lot of both, the market is severely split between winners and losers, and it tends to be a negative for stocks. The chart below highlights all dates when the 10-day moving average of the Nasdaq HiLo Logic Index crossed above 2.5.

Once again, this signal (which occurred most recently on 2024-10-02) does not constitute an automatic sell signal. However, the generally subpar market results following signals should be noted.

Jay also highlighted the level of small-speculator positioning in index futures, which is coming off a record high. Such lopsided exposure has preceded poor returns in stocks.

Utilities' historic momentum

Big funds bought first-order AI-themed stocks like Nvidia, then sold into a retail mania and have since focused on the companies that need to power that theme - utilities. 

These moves helped push the popular XLU fund to 20% above its 200-day moving average. Such a massive move above trend is nearing unprecedented territory for a staid widows-and-orphans fund like this.

We can read much into a few precedents, so the table below looks at every time the Dow Jones Utilities Index jumped more than 15% above its 200-day average. Over the next 2-3 months, utilities showed a strong tendency to reverse part of the momentum, with poor returns and unappetizing risk relative to reward for late buyers. 

As XLU has ground higher in recent months, the internal strength of gains has slipped. The McClellan Oscillator has diverged since August and has mostly held below the zero line for the past few weeks. That activity has caused the longer-term Summation Index to curl and form a peak. The other times it behaved like this, the fund showed poor returns over the next 6-12 months.

During this time, insiders have been on a buying strike. The rolling six-month sum of share purchases among corporate insiders has plunged, showing the lowest buying interest in 14 years. At the same time that insiders were pulling back on their purchases, the (mostly) retail traders in the XLU fund were piling in. The 100-day average fund flow into XLU has surged to the highest level in its history.

Also, correlation among utility stocks has cratered to the lowest in at least 15 years, a stark change from 2022-23, when correlations were significantly higher. This suggests a level of complacency among investors that has typically preceded weaker returns.

Healthcare opportunities 

Several positive factors are coming together for the healthcare sector, as Jay showed the sector recently became oversold while insider selling has plunged, and seasonality will soon be favorable.

The McClellan Oscillator looks at the momentum of the underlying breadth of the market. When it is above zero, momentum is positive; below zero, it is negative. It also works as an overbought/oversold indicator when it pushes above +100 or below -100 respectively.

The chart below highlights those dates when the Health Care Select Sector SPDR Fund (ticker XLV) McClellan Oscillator crossed below -100 for the first time in a month and the positive returns in XLV from 3-12 months later.

Insider selling in the sector has plunged recently. This suggests that healthcare sector insiders still see further upside potential and are presently in "Hold" mode.

The chart below highlights the dates when our Corporate Insider Sells-XLV indicator crossed below 280. The most recent signal occurred on 2024-09-09. This indicator shows the total number of corporate insiders of companies covered by the XLV ETF who have sold shares on the open market during the past six months.

In addition, the chart below shows that the annual seasonal trend for ticker XLV will soon be entering arguably the most favorable time of year. For 2024, this period extends from 2024-10-11 through 2024-12-12.

These windows have shown a positive return 83% of the time, with a median winner about double the size of the median loser. The sector gained more than +15% fifteen times versus losing more than -15% only three times.

Time for semis to shine

Jay further noted that seasonality and an odd sentiment signal presently suggest the potential for another meaningful run higher for semis.

The VanEck Semiconductor ETF (ticker SMH) is entering a favorable period that extends from Trading Day of Year (TDY) #196 through TDY #31 of the following year. This period begins again at the close on 2024-10-10.

Ticker SMH started trading in 2000. To create a more extended test, we will use the Fidelity Select Electronics fund (ticker FSLEX) - which trades with a 0.95 correlation to ticker SMH - as a proxy for this sector. FSELX began trading in 1986. The chart below displays the hypothetical growth of $1 invested in FSELX starting in October 1986. Hypothetically, $1 invested in this manner starting in 1986 is worth $129 now.

Overall, the numbers are compelling. An 84% Win Rate and 31% of all years (12 out of 38) witnessed an advance of +20% or more - while only two years saw a decline of more than -20%. However, it must be emphasized that this is a volatile sector, and significant losses are absolutely a possibility in any given year. FSELX suffered a loss of -38.7% during the 1987-1988 period (with a maximum drawdown of -47.6%) and a loss of -24.6% during 2007-2008 (with a maximum drawdown of -45.3%). So do not underestimate the potential risks.

Sentiment-wise, high Optix readings suggest too much bullishness on the part of traders. However, for SMH we have come across a counterintuitive usage. The chart below highlights all dates when the 3-day average of SMH Optix crossed above 80% while SMH was above its 200-day moving average.

The six- and twelve-month results are extremely compelling, with Win Rates of 88% and 94%, respectively, and Median Returns of 17.69% for six months and 42.30% for twelve months.

More seasonal windows

Jay further noted a wide array of indexes and sectors that are entering a highly favorable seasonal period. This does not guarantee an impending market rally, but when combined with favorable price action, that is generally the way to play until the market tells us otherwise.

The iShares MSCI EAFE ETF (EFA) tracks the MSCI EAFE Index. The chart below displays the annual seasonal trend for EFA and highlights the TDY #196 through #234 period. For 2024, this period extends from the close of 2024-10-10 through 2024-12-04.

The chart below displays the hypothetical growth of $1 invested in EFA only during this period since 2001. That hypothetical $1 has grown to $2.17.

He also noted that the iShares Russell 2000 ETF (IWM) has a positive window from the close of 2024-10-10 through 2024-12-24. The SPDR Dow Jones Industrial Average ETF Trust (DIA) period extends from the close of 2024-10-10 through 2024-12-31, as do the windows for XLP, XLB, and XLK.

Commodities vs. the dollar

It is well-established that commodity prices, in general, tend to trend opposite to the U.S. Dollar. Jay tested this concept.

Our test started on December 31st, 1970, and encompasses almost 54 years of history. The chart below displays the two indexes together.

He looked at the dollar's 26-week exponential moving average (EMA) relative to the 30-week EMA. If it's positive, then dollar is considered to be in an uptrend, which should be unfavorable for commodities, and vice-versa. The chart below displays the difference between the moving averages. 

The chart below displays the hypothetical growth of $1 invested in the Bloomberg Commodity Spot Price Index only during those weeks when the moving average differential above ended the previous week in negative territory. The results saw $1 grow to $43.32.

The chart below displays the hypothetical growth of $1 invested in the Bloomberg Commodity Spot Price Index only during those weeks when the moving average differential above ended the previous week in positive territory. The results saw $1.00 decline to $0.55.

The JK Commodity/Dollar Oscillator has been negative since 2024-08-16. Since that time, BCOMSP has advanced roughly +5.6%.

The results generally hold up well using the Invesco DB Commodity Index Tracking Fund ETF (ticker DBC, which is generally the most actively traded "basket of commodities" ETF).

About TradingEdge Weekly...

The goal of TradingEdge Weekly is to summarize some of the research published to SentimenTrader over the past week. Sometimes there is a lot to digest, and this summary highlights the highest conviction or most compelling ideas we discussed. This is NOT the published research; rather, it pulls out some of the most relevant parts. It includes links to the published research for convenience, and if you don't subscribe to those products, it will present the options for access.