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Chart Advisor: Risky Business

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Wednesday, April 7, 2021

1/ Tech and small caps following diverging paths 

2/ Finance and Energy lead as earnings approach

3/ Will banks lead the second quarter? 

4/ The bottom line

1/ Tech and Small Caps Following Diverging Paths 

Large-cap technology stocks fared better than small-cap technology stocks in today’s session. The difference in the price action between these two classes of stocks has begun to demonstrate a pattern that chart watchers shouldn’t overlook. 

Invesco’s Nasdaq 100 ETF (QQQ) closed slightly higher, while iShares’ Russell 2000 ETF (IWM) made a clear break lower. While these two indexes don’t always move in lock step, they do have a high degree of positive correlation. When trading results diverge as they did today, it is usually worth watching to see if further divergences occur. The more these indications appear, the more investors are showing they are less comfortable with taking risks.

This happened as recently as March 22 (see blue arrows on chart below). The next two days were followed by general selling in the indexes, but it is noteworthy that the impact was harder on the small-cap index, which had showed relative weakness on the signal day. The more this signal shows up, the stronger it becomes an indication of overall market weakness and a lack of commitment among traders and investors to put money in growth opportunities. Were this kind of thing to happen half a dozen times in a three-month period, it would be a very bearish indication. 

2/ Finance and Energy Lead as Earnings Approach

Earnings season begins next week. Chart watchers will want to keep an eye on the movement of market sectors between now and then to get an idea of where professional money managers are likely to place their bets. A simple rule of thumb is that whatever is outperforming other sectors leading into earnings, has a high likelihood of being near the top in a relative performance comparison one month later. The chart below attempts to facilitate this comparison. 

State Street’s sector index funds for Energy (XLE) and Finance (XLF) are clearly leading the pack. It is curious to consider if that trend can continue, but chart watchers won’t have to wait for long since financial companies are front-loaded on the earnings calendar.  

3/ Will Banks Lead the Second Quarter? 

J.P. Morgan Chase (JPM) and Wells Fargo Corp. (WFC) both report earnings before the market opens next Tuesday, April 13. The current price action for both of these stocks shows a generally upward trend, but one that has taken a pause over the past two weeks or so. Surprisingly good news could lead to a break above recent highs. Bad news could drive price action that would violate the upward trend.  

Regardless of which direction these stocks move next Tuesday, there is a good chance it will spark a new short-term trend that could last for the following month or so. As the chart below shows, buying enthusiasm has waned in recent days drawing prices into a tight range. 

4/ The Bottom Line 

Tech stocks rose, but small-caps fell. This divergent attitude towards risk and potential reward may demonstrate a weakening commitment to finding high-growth returns. Conversely, the financial sector looks strongly positioned as earnings season approaches. 

Originally Published on April 7, 2021

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