foxex: Dead Cat Bounce or Bullish Recovery?

Chart Advisor | INVESTOPEDIA

Focus on the Price

By John Jagerson, CFA, CMT

Wednesday, January 23, 2019

1. Equal opportunity earnings season

2. S&P 500 dead cat bounce?

3. Warning sign from consumer sentiment relative strength chart

How can we improve the new Chart Advisor? Tell us at chartadvisor@investopedia.com

Major Moves

Earnings season is off to a good start this quarter. The majority of S&P 500 components that have reported so far have beaten their analyst consensus estimates.

However, traders are being more discriminating as they are deciding between adding to their positions or taking profits. Instead of being a market where the "rising tide is floating all boats," this is more of an equal opportunity market.

In an equal opportunity market, every company has an equal chance to make a bullish case for itself. But if it fails to do so, traders won't hesitate to start selling.

For example, Abbott Laboratories (ABT), Comcast (CMCSA), Procter & Gamble (PG) and United Technologies (UTX) all reported earnings before the opening bell this morning.

During trading today, ABT drifted lower, CMCSA climbed higher and PG and UTX both gapped higher. A year ago, ABT would have likely been dragged higher by the general bullish momentum on Wall Street, but not this year. This year, ABT didn't meet expectations, and it was punished.

I expect this trend to continue as traders remain cautiously optimistic with an itchy trigger finger to sell.

S&P 500

For the second straight day, the S&P 500 has dropped below 2,630 to challenge support as it consolidates around the 50% Fibonacci retracement level of the index's bear-market pullback.

This price action has many traders wondering if the late-December and early-January rally on Wall Street was the beginning of a bullish recovery or if it is simply a dead cat bounce.

On the positive side, the fact that the index has dipped below support each day only to bounce right back up tells us that traders are willing to buy the intra-day dip. This is especially encouraging seeing as how there doesn't seem to be any real progress being made in Congress to end the government shutdown or any real progress being made between the Trump administration and China to ease trade tensions.

On the negative side, the fact that the index is dropping each day and is still hovering below last Friday's high tells us traders aren't convinced the market is going to be moving any higher in the near term.

For solid confirmation of either the resumption of a bullish trend or the renewal of a bearish trend, watch for the S&P 500 to either break higher and close above last Friday's high of 2,675.47 or break lower and close below 2,600.

Read more:

The Dead Cat Bounce of Investing

Investopedia's Oddest Business and Investing Terms
What is a Breakaway Gap?

Source: finviz.com

Risk Indicators

Last month (on December 18), we looked at one of my favorite indicators to gauge market sentiment to see if it would give us any clues about the potential of a bullish bounce on Wall Street, and it played out perfectly.

That same indicator is flashing a bearish signal today. Let's take a look.

The indicator I'm talking about is a relative strength comparison chart between the Consumer Discretionary Select Sector SPDR ETF (XLY) and the Consumer Staples Select Sector SPDR ETF (XLP).

Consumer Discretionary stocks tend to outperform Consumer Staples stocks when investor sentiment is bullish because investors typically put their money in growth stocks when they are confident and are seeking higher returns.

You can see this playing out on the XLY/XLP relative strength chart when the relative-strength line moves higher.

Conversely, Consumer Discretionary stocks tend to under-perform Consumer Staples stocks when investor sentiment is bearish because investors typically put their money in safe, stable stocks when they are less confident and are seeking to protect their capital.

You can see this playing out on the XLY/XLP relative strength chart when the relative-strength line moves lower.

Last month when we were looking, the XLY/XLP chart was on the verge of creating an inverse head-and-shoulders bullish reversal pattern. It completed that pattern a few days later and confirmed a shift from bearish to bullish sentiment on Wall Street.

After a strong move higher in early-January, the XLY/XLP chart started to consolidate in a pennant formation just above 2.0. Pennants are fantastic price patterns because they give clear breakout points to watch with a clean down-trending resistance level and up-trending support level.

Today, the relative-strength line broke through the up-trending support level that served as the bottom of the consolidation range. This breakout confirmed the completion of the bearish reversal pattern.

Seeing this confirmed pattern doesn't guarantee a reversal, but it could be an early signal that investor sentiment is starting to shift from bullish to bearish.

Read more:

What is Relative Strength?

Comparing Consumer Discretionary Mutual Funds to XLY (VCDAX)

Top Performing Consumer Staples ETFs in 2018

Bottom line: Support is tenuous, at best

Seeing the S&P 500 continuing to challenge support at 2,630 while the XLY/XLP relative strength chart is confirming bearish reversal patterns tells us we need to maintain constant vigilance during the next few trading days.

A dead cat bounce is not a foregone conclusion, but it is still a distinct possibility.

Tax Deductions That Went Away This Year

Learn fundamental analysis strategies used by the most successful investors