The Week Ahead in Stocks – May 29

Sector rotation is something we monitor. Not because we necessarily want to rotate out of one group of sectors into another, but because it can highlight good opportunities and keep us out of trouble.

A look at the year-to-date performance of the SPDR sectors confirms what we suspected anyway; rising rates have pressured XLP, XLU and XLRE, while XLY, XLE and of course XLK have been the strongest.

But this doesn’t mean we have to avoid the likes of XLU like the plague. Generally we would like to hold stocks in the strongest sectors as this gives us a higher probability of a successful trade. But clarity can at times be much lower in strong sectors and higher in the weaker ones. Take the recent move in TLT and XLU, for example.

TLT made a very clear trend sequence into the May 17th low and reversed on the 18th May. Meanwhile, XLU also made a clear trend sequence lower, albeit in half the time. It actually made a new low on 18th May, as TLT was reversing, but it soon followed higher, as we would expect, and is now 4% higher.

XLI is another sector to make a nice move from a clear set up.

While we do see the benefits of trading with the trend and in strong sectors/names, there is nothing wrong with being contrarian or bottom picking when the set-up is clear and probabilities are in our favour. This is why we devise a Matrix Score for each trade, incorporating Risk, Reward, and Probabilities based on some of the factors we have discussed.

Going forward, XLK continues to be one of our favourite sectors, although having already underperformed the SPX recently in one of its temporary spikes lower, the best opportunities are likely behind us for a few months as it likely drifts higher.

XLE is quite possibly a sector to avoid, as at last oil has reversed from just above our long-standing $71.28 target.

Actually the last sequence higher (wave C) looks a bit short and out of proportion, and there could be a drift higher to new highs in a wedge type pattern. Nevertheless, when clarity is low, so is our Matrix Score for potential trades and we can simply look for something better. There are plenty fish – or sectors – in the sea.

Good luck and good trading.

Andrew McElroy
Chief Stocks Analyst

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