S&P In Confirmed Breakout But Near-term Gains To Be Limited By Overbought Conditions

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Good Morning, this is Capital Essence’s Market Outlook (the technical analysis of financial markets) for Thursday August 6, 2020.

We’ve noted in the previous Market Outlook that: “S&P broke key resistance Tuesday, signified the short-term range bound trading pattern had resolved itself into a new upswing.  While the overall technical backdrop remains positive, return of overbought conditions might put a cap on the upside.  With this in mind, we’d look to reduce exposure into overbought strength, which might take the S&P closer to the late February bearish breakaway gap, around 3330, before a significant pullback unfolds.”  As anticipated, S&P ended higher on Wednesday, advanced 0.6 percent to 3,327.77, on optimism that U.S. lawmakers will agree to a fresh round of coronavirus stimulus sooner than later.  The Dow Jones Industrial Average rose 1.4 percent to 27,201.52.  The Nasdaq Composite climbed 0.4 percent to 10,998.40.  The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, fell more than 3 percent to 22.99.

A sea of green washed over stocks as investors cheered signs of progress on the virus aid bill, which many believe is critical to support the economy’s nascent recovery. The bill could also include further aid for airlines after 16 Republican Senators reportedly called for $25 billion in federal aid for the airline industry to be included in the virus relief package amid fears of looming job cuts as payroll assistance is set to end on October 1.  American Airlines (AAL) surged 10 percent, United Airlines (UAL) was up 4 percent and Delta Air Lines (DAL) added percent.  As such, the iShares Transportation Average ETF (IYT) jumped 1.3percent on the day but is down about 8 percent YTD, underperformed the S&P.  Now the question is what’s next?  Below is an update look at a trade in IYT.

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 – iShares Transportation Average ETF (weekly)

Our “U.S. Market Trading Map” painted IYT bars in green (buy) – see area ‘A’ in the chart.  Just so that you know, initially profiled in our June 12, 2020 “Core ETF Portfolio” the long IYT position has gained about 12 percent.

As shown, IYT has been on a tear in recent weeks after the early June correction found support near the late May breakout point.  This week’s rally pushed the ETF above the 4-year moving average, a key technical level based on moving averages. This level was tested several times over the past years.  A close above 179 on a weekly closing basis will confirm the bullish signal and set the stage for a rapid advance toward the early 2018 high, just above 200.

IYT has support near 174.  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 bullish (buy).  Last changed July 29, 2020 from bearish (sell) – (see area ‘A’ in the chart).

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

As expected, S&P moved up to test resistance at the lower boundary of the red band after breaking out above the important sentiment 3300 earlier this week.  That level roughly corresponds with the late February massive selloff.  This is a positive development but traders should be mindful that a trade above the lower boundary of the red band indicates extreme overbought conditions.  The normal behavior for the S&P has been to consolidate and retreated almost every time it traded above that level so there is a high probability that a significant consolidation pattern will again develop in this area.

Near-term, while some backing and filling would not be a surprise, the bulls will continue to have the benefit of the doubts as long as S&P holds above 3240.

Short-term trading range: 3240 to 3400.  S&P has minor support around 3290.  A failure to hold above that level has measured move to around 3240.  Resistance is at the lower boundary of the red band, around 3330.  A breakout above that level has measured move to around 3400.

Long-term trading range: 3100 to 3600.  S&P has support near 3100.  A failure to hold above that level has measured move to 2700.  The index has resistance near 3450.  A close above that level has measured move to 3600.

In summary, S&P has confirmed a breakout above key resistance in a reflection of improved momentums.  Market internals remain supportive of further upside follow-through. Nonetheless, we expect near-term gains to be limited by overbought conditions. While some backing and filling would not be a surprise, the bulls will continue to have the benefit of the doubts as long as S&P holds above 3240.


Thanks and happy trading.

(By:Michelle Mai for Capital Essence)

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