Traders Remain Confident In The Stock Market

08/17/09 09:38:13 AM

by Alan R. Northam

There are many ways to measure the confidence of traders to the stock market. One way is to determine if the Consumer Staples market sector is underperforming or outperforming the S&P 500.

Security: XLP
Position: N/A

The Standard & Poor's 500 is a large basket of 500 stocks representing a cross-section of market sectors that make up our economy. These 500 stocks have been dividing up into nine basic market sectors known as Select Sector SPDRs, of which the Consumer Staples market sector is one. Of these nine market sectors, three are defensive market sectors: Consumer Staples (XLP), Healthcare (XLV), and Utilities (XLU). Defensive sectors represent those products and services that consumers cannot do without, no matter what the economy is doing. In particular, the Consumer Staples market sector includes stocks representing companies that produce food, personal care items, beverages, and so forth.

Figure 1 shows the weekly closing price line chart of the Consumer Staples market sector (XLP). This figure shows that the Consumer Staples market sector put in a bottom by forming a reverse head & shoulders pattern from October 2008 to July 2009. Reverse head & shoulder patterns are typically bottoming patterns that signal a major trend change in the market and is now signaling that the major trend for the Consumer Staples market sector is now upward.

To predict the minimum expected upward move, the measurement rule is used. This rule states that you take the depth of the head from the neckline and project it upward from the breakout of the beckline. This then projects an expected minimum upward rally to approximately $28.75. Keep in mind, however, that this is a minimum expectation. In reality, XLP may not rally all the way to $28.75 before turning back downward, or it may rally well beyond this minimum expectation.

FIGURE 1: XLP, WEEKLY. This chart shows the weekly closing price line chart of the Consumer Staples Select Sector SPDR. This chart also shows the OBV indicator and the price relative ratio line.

Graphic provided by: StockCharts.com.

On-balance volume (OBV) is an indicator that measures volume by adding up volume and subtracting down volume, and the result is an accumulation of volume. When the OBV line is moving higher, it tells us that buyers are in control of the market and when it is moving downward, sellers are in control. Over the last couple of months, OBV has been moving sideways, signaling that neither buyers nor sellers are currently in control of this market. As a result, I would not expect XLP to move significantly higher in the near term. XLP may simply drift higher, or it could turn back down to test support from the neckline.

Below the OBV chart in Figure 1 is the price relative chart. Price relative is derived by dividing the Consumer Staples market sector by the S&P 500. This then compares the market sector to the overall stock market. From this comparison, it can be determined if the market sector is outperforming or underperforming the overall stock market. When the price relative line is moving upward, it signals that the market sector is outperforming the broader stock market, and when it is moving downward, it is underperforming the broader stock market.

In Figure 1, I have added a simple 20-week moving average to help in this comparison. From the figure we can see that the price relative line is below the 20-week moving average (MA) and the MA is moving lower. This signals that while the Consumer Staples market sector has put in a bottom and is moving higher in price, it is underperforming the S&P 500. This indicates that there are other market sectors within the S&P 500 that are outperforming the Consumer Staples market sector. This further suggests that while there is some trading participation within the defensive market sectors, the majority of trading participation is outside the defensive market sectors. For confirmation, we would have to look at the Healthcare and Utilities market sectors.

The Consumer Staples market sector has formed a reverse head & shoulders pattern, signaling that this market sector has put in a major bottom and is now in a long-term upward trend. However, when compared the the S&P 500, it has been shown that the Consumer Staples market sector is currently underperforming the broader stock market. This indicates that the majority of traders and investors are not running to the defensive market sectors for protection of their portfolios. This further indicates that traders and investors remain confident about the future of the stock market and the economy. As long as this confidence continues, we should see higher stock prices in the future and any reversals in price should be considered corrective and not the beginning of a new downward trend. A trend in motion stays in motion until proven otherwise.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.