S&P In Overbought Correction But Downside Risk Could Be Limited

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Good Morning, this is Capital Essence’s Market Outlook (the technical analysis of financial markets) for Tuesday September 1, 2020.

We’ve noted in the previous Market Outlook that: “the fact that market is overbought as S&P poked its head into the level that had been successful in repelling price action in the past suggesting that the market is likely to pare back and consolidate before heading higher again.  So, we would look to increase upside exposure on market dips rather than chasing breakouts.”  As anticipated, S&P ended Monday lower as investors looked warily at U.S. and overseas COVID-19 numbers. Also contributed to the overall weakness were declines in bank stocks.  JPMorgan Chase, Citigroup, Bank of America and Wells Fargo were all down more than 2 percent, following Treasury yields lower. Yields fell after Federal Reserve Vice Chairman Richard Clarida said rates won’t go up just because unemployment goes down.

For the day, the S&P dipped 0.2 percent to 3,500.31.  The Dow Jones Industrial Average slid 0.8 percent to 28,430.05. The Nasdaq Composite outperformed with a 0.7 percent gain and ended the day at 11,775.46.  The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, surged more than 15 percent to 26.48.

Energy stocks led the move lower in the Dow as oil prices struggled in the wake of data showing U.S. crude production rose 4.2 percent to 10.436 million barrels per day in June, renewing oversupply concerns.  As such, the Energy Select Sector SPDR ETF (XLE) tumbled 2.17 percent on the day and is down more than 40 percent YTD, underperformed the S&P.  Now the question is what’s next?  Below is an update look at a trade in XLE.

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 – Energy Select Sector SPDR ETF (weekly)

Our “U.S. Market Trading Map” painted XLE bars in red (sell) – see area ‘A’ in the chart. Over the past few weeks, XLE has been basing sideways using the early May breakout point as support after the March recovery rally ran out of steam near the 38.2% Fibonacci retracement. The overall technical backdrop remains negative, suggesting that the ETF might take a leg lower as soon as it works off oversold conditions.  Support is around 35.  A close below that level on a weekly closing basis will confirm this and a retest of the March low, around 23, should be expected.

XLE has resistance near 39.50.  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 August 20, 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 down to test support at the important sentiment 3500 mark after the late August rally found resistance near the lower boundary of the red band.  As mentioned, the normal behavior for the S&P has been to consolidate and retreated almost every time it traded above that level, the way we had in June, so there is a high probability that a significant consolidation pattern will again develop in the coming days.

While seemingly vulnerable to short-term weakness, the overall trend and the Money Flow measure continue favor the bulls so we believe that any dips are a buying opportunities rather than time to take profits and get out.

Short-term trading range: 3440 to 3530.  S&P has support around 3485.  A failure to hold above that level has measured move to around 3440-3400.  Resistance is around 3520.  A breakout above that level has measured move to around 3600.

Long-term trading range: 3100 to 3730.  S&P has support near 3300.  A failure to hold above that level has measured move to 3100.  The index has resistance near 3520.  A close above that level has measured move to 3730.

In summary, an overbought pullback consolidation interrupted the late August rally in the S&P.  Although seemingly vulnerable to further short-term weakness, the overall technical backdrop remains positive so sell-off could be shallow because the sideline money will try to fight its way back into the market.

 

Thanks and happy trading.

(By:Michelle Mai for Capital Essence)

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