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Chart Advisor: Even More Inflation

Investopedia

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Investopedia
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Monday, May 3rd, 2021

1/ Rise of the blue chips 

2/ The reach of the scarcity trade  

3/ Homebuilders sitting atop best gains 

4/ The bottom line

1/ Rise of the blue chips 

Today’s trading session saw State Street’s Dow Jones Industrial Average ETF (DIA) close higher and Invesco’s Nasdaq 100 Index ETF (QQQ) close lower. This dramatic divergence has been part of a multi-month trend that has propelled blue-chip stocks higher, leaving chart watchers to wonder if this price action is trying to tell us something. 

The chart below makes an interesting comparison by graphing a relative-strength line of DIA divided by QQQ, depicted by the black line, and comparing that with State Street’s S&P 500 ETF (SPY), depicted by the orange line. This allows us to see whether the relative strength between DIA and QQQ is a meaningful indication of trend change for the markets in general.     

The left panel of the chart below shows the last time this dramatic trend showed up for any length of time. A severe down trend did occur just after it manifest in late 2018. The conventional wisdom among seasoned technical analysts is that this kind of indication occurs as investors step back from growth stocks and into the safer harbors of more established, dividend-paying companies.  

It follows then that this price action is inspired by well-informed investors feeling fearful about a coming fall in prices. Institutional investors and professional portfolio managers, for example, know that when they have a strategy to take profits and move money away from more risky securities, it means they better get positions in safer stocks first. It is difficult to say whether that is the psychology behind the current trend right now, or if investors are just betting on a resurgence from brick-and-mortar companies as pandemic restrictions ease.  

2/ The Reach of the Scarcity Trade  

DIA is more than twelve percent higher so far this year. But shortages in basic materials and building supplies have driven some sectors and industries much higher. The chart below compares State Street’s sector index ETFs for Basic Materials (XLB), Finance (XLF), and Energy (XLE) with its Homebuilder Industry ETF (XHB) and Invesco’s MSCI Global Timber ETF (CUT).  

Though most people have heard about the startling increases in the price of lumber, it isn’t the biggest price increase out there. XHB is a clear leader among this group. The important idea to decipher here is whether these represent longer-term trends of inflation, or if this is a short-term bubble based on supply constraints.  

The fact that both the energy and financial businesses are reacting similarly to an industry clearly hampered by supply suggests that this dynamic may be bigger than a mere supply constraint. However, chart watchers will want to keep an eye on XLF over the next month. If it drops away from the others, the supply bubble may be likely to evaporate before long. 

3/ Homebuilders Sitting Atop Best Gains 

Since XHB seems to be outperforming many other index ETFs, it seems worthwhile to have a closer look at some of it’s major components. The chart below compares D.R. Horton (DHI) and Lennar (LEN) homebuilding companies with appliance maker Whirlpool (WHR), Home Depot (HD) and Lowe’s (LOW) as supplier companies. The clear difference between the suppliers of the stuff that goes in a new home and the companies that build the new homes themselves, demonstrates where the strongest demand is right now. Either this demand will be filled by supply constraints, or the stocks in this grouping that are currently lagging behind will catch up. 

4/ The Bottom Line 

Investors made a move towards safety today. The last time this kind of price dynamic showed up for any length of time it was a strongly bearish indication. This time it might be simply an artifact of post-pandemic hangover delaying supplies getting to market. 

Originally posted on 3rd May, 2021

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