Chart Advisor: Overhead Supply Wins

Articles From: Investopedia
Website: Investopedia

By J.C. Parets & All Star Charts

Monday, 26th June, 2023

1/ How Will Tech Correct?

2/ Fragile Trends for Financials

3/ Breakdown in EFA/SPY

4/ France Halts Its Advance

Investopedia is partnering with All Star Charts on this newsletter, which both sells its research to investors, and may trade or hold positions in securities mentioned herein. The contents of this newsletter are for informational and educational purposes only, however, and do not constitute investing advice.

1/ How Will Tech Correct?

The strongest stocks and indexes have been running into clear overhead supply zones and pulling back in recent weeks. Today was no different with large-cap discretionary, communications, and technology leading the major averages lower.

Let’s look at the strongest sector index of them all, the Large-Cap Technology Sector SPDR (XLK), to get a read on where we’re headed from here:

Two weeks ago, XLK came within pennies of testing its 2021 highs before printing a large bearish candle. It has been trending gradually lower ever since, with five of the last six sessions closing in the red.

However, it’s important to put the trend in context as we determine how severe the nature of this selloff has been. Technology stocks have rallied more than 50% from their lows in Q4 of last year. The relative trend is trading at its highest level since 2000, and momentum is in a bullish regime, having just registered its highest reading since 2021. 

Long story short, tech has been on absolute fire and a few down days don’t change that. The entire group has earned a breather. We’re giving tech stocks the benefit of the doubt here and think some corrective action could be healthy.

While the leaders grapple with overhead supply, the lagging indexes are still holding firmly above key support levels. This is true for small caps, financials, and energy just to name a few.

When we look for tactical support levels, in most cases it is the pivot lows. However, when it comes to the structural trend, it is all about the prior-cycle highs. Here’s a look at what we mean, using the Invesco Equal-Weight Financials Index (RSPF) as an example:

The regional banking crisis brought this index to fresh two-year lows back in March. 

While more and more of the overall market has bought into the growth stock rally over the past quarter, financials haven’t budged. We’ve drawn a little coil, or short-term bearish continuation pattern in blue to illustrate this.

A short-term bearish formation is one thing, but where it is occurring is the true cause for concern. RSPF is rather vulnerable at the current level as the lower bounds of this coil represent the 2018 and early 2020 highs. If this range resolves lower and bears take control at this critical polarity zone, the entire sector could experience a fresh leg down.

3/ Breakdown in EFA/SPY

The current bull run for stocks started off with impressive outperformance from international equities, namely those in the eurozone. However, this relative strength stalled out earlier in the year and the trend is now accelerating to the downside.

We like to analyze the performance between the U.S. and international developed equities by using the ratio of the MSCI EAFE Index (EFA) versus the S&P 500 (SPY). As shown below, EFA/SPY violated a key support zone last month when it resolved lower from a multi-month topping pattern:

While this pattern breakdown just occurred, the outperformance from EFA ended way back in January when the ratio peaked. Over the past few months, the performance gap has widened as the S&P 500 has been rallying higher while EFA has moved lower. This has caused the relative ratio to fall at a faster rate.

The short-term topping pattern is being confirmed by an oversold momentum reading in the lower pane. Maybe more importantly, it is being confirmed by the absolute trends in international equities, many of which have printed failed breakouts at former highs recently.

4/ France Halts Its Advance

European equities have been leaders during the new bull cycle. However, as discussed above, evidence is mounting that they are on the verge of a pause.

France’s CAC 40 Index is an excellent example of this, as it pierced through the upper bounds of a big basing pattern but quickly failed and reversed back into its old range, causing a failed breakout.

Although the bullish momentum regime (as measured by the 14-period RSI) remains intact, momentum has been waning as of late. The result is a potential bearish divergence as the price returns below a shelf of former highs.

This begs the question as to whether this is a potential failed move, and prices are about to reverse to the downside, or just a false start.

Originally posted 26th June 2023

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