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Chart Advisor: Onward and Upward

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Wednesday, November 04, 2020 Headlines

1. Markets accept more risk as they move on from elections
2. A highly unusual bearish chart pattern that is actually bullish
3. Are these sectors prone to lagging behind?

Market Moves

Brushing aside lingering uncertainty over the U.S. election results, investors took on additional risk by adding to their portfolios. This was encouraged by option sellers who significantly lowered their risk premiums. The Cboe Volatility Index (VIX) fell more than 16 percent today and closed below 30, signaling a likely mild conclusion to the election uncertainty.

Leading up to the election investors had appeared to pare back their demand for more risky positions, with one exception: small-cap stocks. The chart below compares the iShares’ Russell 2000 ETF (IWM), with State Street’s S&P 500 Index Fund (SPY) and Midcap 400 Index Fund (MDY), as well as Invesco’s Nasdaq 100 fund (QQQ).

While the small-cap index was nearly unchanged today, its overall move has been stronger over the past four months than both mid-cap and large-cap stocks. The small-cap index is also very near its highest ranges, where the others still have a small upward move needed to get there. This shows that even though investors weren’t feeling the need to play catch up with small caps (as they did with the others) they didn’t feel the need to leave them behind either. That translates into a bullish signal for the market in general.

A Highly Unusual Bearish Chart Pattern That is Actually Bullish

When a stock hits resistance, its price action can often spend days in smaller than usual trading ranges. When one such day is punctuated on either side by larger than usual trading ranges (gaps included), the patterns that result are often considered to be short-term trend reversal indicators. The best known of these patterns is called an evening star formation.

One rare form of this formation is so unusual that it has its own name in the annals of Japanese Candlestick lore: the abandoned baby pattern. The chart below displays three instances of this pattern among the following stocks: NextEra Energy (NEE), International Business Machines (IBM), and Bank of America (BAC). The pattern generally indicates that the prices are slightly more likely than not to trend lower over the next one or two weeks.

The fact that these instances occurred on otherwise blue-chip company stocks is interesting. It implies that money is moving out of these stocks and, presumably, into more risky positions. That is usually a bullish indicator because, in general, it means investors prefer to keep more of their money invested, rather than kept safe.

Are These Sectors Prone to Lagging Behind?

The third chart for today’s newsletter compares two of State Street’s sector index ETFs for Basic materials (XLB) and Utilities (XLU). These sector funds not only pushed lower today (despite the broad market indexes moving upward), but have been in a bit of a sideways range for the past month or so. It seems strange to expect the market to be going higher while these stocks are not. To be fair, these sectors tend to under-perform the market averages during bullish times, but they don’t often simply sit still. The fact that they are now creates a bit of concern about the future of the budding new bull market move.

The Bottom Line

Stocks rose and volatility fell as investors showed themselves willing to move beyond the election uncertainty. Select stocks in some of the laggard sectors are showing resistance. This could mean that the current surge higher isn’t spreading itself out very widely just yet.

Originally Published on November 4, 2020

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