S&P Extremely Oversold but Upside Reward Could be Limited

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Good Morning, this is Capital Essence’s Market Outlook (the technical analysis of financial markets) for Friday December 21, 2018.

Stocks tumbled on Thursday as ongoing concerns over trade, politics, and economic growth added to worries over a Fed policy mistake.  For the day, the S&P dropped 1.6 percent, the Dow Jones Industrial Average lost 2 percent and the tech-heavy Nasdaq Composite lost 1.6 percent.  The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, surged nearly 11 to 28.38.

Cyclical sectors sold off sharply Thursday amid concerns about a slowdown in global economic growth.  The Consumer Discretionary Select Sector SPDR ETF (XLY) tumbled 2.24 percent on the day and is down nearly 2.4 percent YTD, outperformed the S&P by a wide margin.  Now the question is whether recent selloff is a pause that refreshes or it’s a beginning of something worse?  Below is an update look at a trade in XLY.

The graphics below are from our “U.S. Market Trading Map”, show the near-term technical bias and trading ranges.  As shown, the underlying is in a short-term bullish trend when the price bars are painted in green.  The underlying is in a short-term bearish trend when the price bars are painted in red.  The yellow bars identify period of neutral or sideways trading pattern.  Additionally, the light-blue shading represents the short-term trading range.  A move above or below that range is considered overbought (as represents by the red shading) or oversold (as represents by the dark-green shading).  Readings above or below the red and green shaded areas are considered extremely overbought or extremely oversold.

Chart 1.1 – Consumer Discretionary Select Sector SPDR ETF (weekly)

Our “U.S. Market Trading Map” painted XLY bars in red (sell) – see area ‘A’ in the chart.  The first dominant feature on the chart is the rising trend line starting in late 2015.  The second dominant feature of the chart is the downward trend since early October 2018.  This week’s massive selloff pushed the ETF below the 38.2 % Fibonacci retracement and the 2-year moving average, an important hurdle based on moving averages. This is a bearish development, opened the flood gate toward the 89-86 zone, or the 4-year moving average and the 50% Fibonacci retracement.

XLY has resistance just above 99.  Short-term traders could use that level as the logical level to measure risk against.

Chart 1.2   – S&P 500 index (daily)

Short-term technical outlook remains bearish (sell).  Last changed December 4, 2018 from bullish (buy) (see area ‘A’ in the chart).

[Note: for more details analysis, please take a look at our “US Market ETF Trading Map”]

Thursday’s massive selloff pushed the S&P below its normal trading range and into extreme oversold territory (as represents by the dark-green band in the chart).  While extreme oversold condition is normal during long-term downtrend, it suggested that downside momentum might not sustain without at least a short-term breather.  In fact, current trading pattern is very similar to October selloffs.  As shown, after fell below the bottom of its short-term trading range on October 11, the index rebounded nicely after meeting anticipated resistance at the 2800 zone.  With that said, if history is any guidance then traders should expect at least an attempt to rally toward immediate resistance at the 2500-2530 zone.

On the upside, 2600 is the line in the sand.  There is a no reason to turn particularly bullish until this area is eclipsed.

Short-term trading range: 2350 to 2530.  S&P has a strong band of support near 2380-2350.  The index has resistance near 2500-2530.  A close above 2530 could trigger acceleration toward the 2700 zone.

Long-term trading range: 2350 to 2930.  S&P has support near 2530.  A close below that level on a monthly basis has measured move to 2350.  The index has resistance near 2740.  A close above that level has measured move to 2950.

In summary, the S&P is extremely oversold following recent decline.  Like a rubber band, stocks tend to snap back to the mean if they have dropped too far from the “fair” value. With that said, if lower stock prices create some values for investors, then, given everything being equal, the market should be able to find some buyers.  However, give the significant damage that had been done over the past weeks, upside reward could be limited.


Thanks and happy trading.

(By:Michelle Mai for Capital Essence)

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