Canaries in the Coal Mine

Hey 5-Star Trader,

Last week, the indexes, particularly the Nasdaq (QQQ) were holding up above the 50-period simple moving average on the daily chart. This is a key, line in the sand, as it can often be an excellent buy location on a dip. However, I always tell traders to exhibit caution at this level because just as easily, this can be the location on the chart where the technicals break down, we see a big flush, and selling starts coming through.

I’ve been hesitant overall to get long in this market, with the exception of energy stocks. Energy has been the strongest sector, and as usual, I like to identify strong trends and jump on them until they lose momentum. Just last week, we began to see cracks forming in the energy sector, as crude dropped below $100 a barrel, and XLE briefly reverted to the 21-period exponential moving average on the daily chart. However, the key technical break was the combination of the break below $100, and the break below the 50 SMA on a daily chart of crude futures (/CL). Now, I’m not calling the end of the rally in energy, but, I am starting to see some cracks, and that means I’m going to be careful with long positions in this sector. Why? With the strength we have seen, it is bound to pull back at some point.

In moments like these, I always find it helpful to consult the Phoenix Finder Turbo, as it quickly identifies relative strength and weakness, along with some cracks showing up – what I like to call the canaries in the coal mine.

I call them canaries in the coal mine because typically when we start to see some shifts, particularly in key and pivotal sectors like technology (XLK), semiconductors (SMH), and consumer discretionary (XLY), this is a very big waving red flag that says, ‘CAUTION!’

In the Phoenix Finder, this shows up as dark red and then bright red boxes to the right of the grid, next to the name of the sector, index or industry group. Those red boxes demonstrate that that ticker has shifted from what was a bullish or neutral move, into bear mode. And, that means it’s time for traders to take note of the canary in the coal mine – the first to fall when the air gets a little tough to breathe in.

In this case, we can see quite a bit of weakness in housing. This makes sense as rapidly increasing interest rates in combination with inflation and supply chain shortages have been weighing heavily on this sector.

Banks (XLF) are demonstrating weakness going into earnings – another ominous sign. I don’t like to see tickers or sectors trade lower into earnings (well, unless I’m short!) as it’s not a good sign for that sector or ticker upon the actual report. 

Healthcare (XLV) and Consumer Staples (XLP) remain strong, along with Energy (XLE). But, the biggest waving red flags here are cybersecurity (HACK), cloud computing (SKYY), technology (XLK), and semiconductors (SMH). Why? These stocks make up such a large percentage of not just the Nasdaq, but also the S&P. It’s next to impossible for the S&P to hold on when all of these areas of the market are being weighed down.

When I woke up on Monday morning and saw that Microsoft (MSFT) had gapped down over 3% and the 10-year treasury index (TNX) was up over 2%, I knew there was a very high chance of the Nasdaq retesting 2022 lows very soon. Earnings are upon us, and like I noted last week, I’m not anticipating upside fireworks from the banks. I am especially not anticipating major upside fireworks from technology. With a lack of these catalysts, it is going to be very difficult for the market to pull its way off of the lows. 

The Federal Reserve is hiking rates, and planning on doing it quickly, and the market continues to show its displeasure. 

So, what is a trader to do? I’m regularly eyeing long-term stock purchases in my long-term account. After all, these kinds of market corrections don’t come around very often. I’m also focusing on trading relative weakness to the downside – and relative strength, to the upside.  I did try getting two – what were supposed to be – relative strength longs in Microsoft and Apple. Going into this earnings season, I thought for sure, based on statistics, technicals, and fundamentals – that if there were any technology stocks that could rally prior to earnings, it would be those two. With the moves in those stocks on Monday, those hopes are now dashed and gone, and the red flag keeps waving.

-Danielle =)

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