Health Care Determines Market Direction

08/20/09 12:39:23 PM

by Alan R. Northam

There are many ways to measure the expected future direction of the overall stock market. One way is to determine what the defensive market sectors are doing.

Security: XLV
Position: N/A

Since March 2009, the stock market has come a long way in retracing its losses from the October 2007 stock market top. As a result, some market technicians are calling for a market top and the resumption of the bear market. There are also other market technicians forecasting a higher stock market going forward. Which camp are we to believe, those who are bullish or those who are bearish? One way to determine what the stock market is going to be doing in the days, weeks, and months ahead is to keep an eye on what the defensive market sectors are doing. When the defensive stock market sectors start to outperform the overall stock market, it is a signal that traders and investors are worried about the future of the stock market and they are heading for cover.

The Standard & Poor's 500 is made up of 500 individual stocks representing a cross-section of market sectors that make up our economy. These 500 stocks have been divided up into nine basic market sectors known as the Select Sector SPDRs, of which the health-care market sector is one. Of these nine market sectors, three are defensive market sectors and include Healthcare (XLV), Utilities (XLU), and the Consumer Staples (XLP). Defensive sectors represent those products and services that consumers cannot do without no matter what the economy is doing. In particular, the health-care market sector represents those health-care products and services that consumers cannot do without.

Figure 1 shows the weekly closing price line chart of XLV. This figure shows that the health-care market sector has been moving higher since March 2009 right along with the broader stock market as well as other market sectors. Since this market sector started rallying off the March low, the health-care market sector continues to trade above its intermediate-term trendline, but it remains below its long-term downtrend line.

FIGURE 1: XLV, WEEKLY. This shows the closing price line chart of the Health Care Select Sector SPDR. This figure also shows the on-balance volume as well as the price relative line chart.

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. Looking at OBV, note that it has been in a downward trend since February, while price continues to move higher, signaling a lack of commitment by the buyers. When price moves upward while volume moves downward, it creates a negative divergence, which is a bearish condition.

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. Note that the price relative ratio line has been forming what looks to be a head & shoulders topping signal since October 2008. However, this topping pattern is incomplete. To complete the head & shoulders topping signal, the ratio line needs to break down below the neckline of the H&S pattern.

While XLV continues to move higher in price, volume continues to wane, signaling a lack of commitment by the buyers to this market sector. In comparing the health-care market sector to the S&P 500, it looks like a head & shoulders topping signal is in the making, warning that the health-care market sector may not start to outperform the broader stock market going forward. As a result of this analysis of the health-care market sector, it does not appear that traders and investors are starting to heading to the defensive market sectors to reduce the risk of their market exposure. Therefore, there is no reason to expect a broad stock market top at this time and higher prices should prevail.

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.