Are Semiconductors Warning of Future Tech Sector Weakness?

Back in 2014 I wrote a post (which Bloomberg picked as their Chart of the Day) outlining how semiconductors had replaced copper as the new barometer for the market. For quite a while copper was thought to have had a PhD in economics, as its price movement acted as a good indicator of economic activity. As the U.S. (and the global) economy shift to be more technology-focused, semiconductors took over at head of the class.

With the prominent use of semi’s in the tech space, they become an obvious tool to be used in evaluating the technology sector. Below is a chart showing the relative performance ratio between semiconductors ($SMH) and the S&P 500 ($SPY), with its respective Relative Strength Index (RSI) in the top panel.

Over the last several years when momentum, as measured by the RSI, diverges (making a lower high as the ratio between $SMH and $SPY makes a higher high), a trend reversal often follows as semiconductors begin to under-perform the overall U.S. equity market. This has also led to lackluster performance by the tech sector ($XLK) as well. In the bottom panel of the chart we have the ratio of $XLK and $SPY, and when $XLK is outpacing $SPY (by either going up more or going down less) the line rises.

The opposite is also true, when momentum for the $SMH and $SPY ratio creates a positive divergence, as it did in February of this year and August of last year, the tech sector’s trend in under-performance has reversed.

Since early November, semiconductors have seen a strong performance. and recently the ratio between semi’s and the S&P 500 made an attempt to break to a new high, surpassing its prior October peak. However, the breakout was accompanied by a bearish divergence in momentum and as of this writing, has failed to hold. This false breakout and bearish divergence creates a poor environment for $XLK, as its relative performance often mirrors that of semiconductors. I think it’s also important to note that while the $SMH-$SPY ratio got back to its prior October high, the $XLK-$SPY ratio did not, an additional sign of technology weakness.

smh-spy

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Will We See A Shift Out of High Yield Bonds and Back to Treasury’s?

Since the election last week the markets has been digesting the new set of expectations with regards to where growth is expected to increase (small caps, biotech seeing large pops) or decrease (large cap tech). The same type of movement is also taking place in the bond market with Treasury’s seeing a fair bit of weakness as rates rise. The 10-year Treasury yield is now at its highest level for the year with many bond ETFs seeing their lowest levels. On a relative basis, high yield debt has not been hit as hard as government debt, which is the focus of this post.

Below is a ratio chart comparing the iShares High Yield Corporate Bond ETF ($HYG) vs. the iShares 20+ Year Treasury Bond ETF ($TLT). As a reminder, when looking at a ratio chart like this, if the line is rising then the numerator, int his case, $HYG, is rising more or falling less than the denominator (i.e. $TLT). This is a great way to be able to analyze two markets and see which one has stronger relative strength. The second half of 2016 has seen a shift to favoring high yield debt over Treasury’s. This increase in relative performance has sent the Relative Strength Index (RSI), a momentum indicator, to a historically high level. In fact, we’ve only see four previous instances where the RSI has been this high for the HYG/TLT pair since 2007.

As shown by the dotted blue lines, when RSI has gotten this high in the past we’ve typically seen a reversal in relative strength. Three of the four prior occurrences (2007, 2010, 2015) were substantial shifts in trend while the instance in 2012 didn’t have a complete about-face in relative performance, we did see TLT pick up a little in relative performance for several weeks before bottoming out and $HYG continuing to lead for the bulk of 2013.

So while the sample size is extremely small, it does appear the trend for high yield debt  leading Treasury’s has come to an impasse. Momentum has become stretched and this elevated reading in the RSI can be resolved in two ways…. through time, which means we could see a consolidation in the $HYG/$TLT ratio or a reversal in trend. However, as we saw in 2013, the magnitude of the trend reversal may not last very long or produce dramatic changes in the overall trend. 

hyg-tlt

 

Following A Process Can Serve Many Purposes

This post is not an endorsement for my firm’s asset management services nor is it a recommendation to buy or sell securities mentioned. Everything written here (like all my posts) is for education purposes only.

Back in July I wrote a post about following your process through thick and thin, discussing a trade I had missed because I strayed away from following my procedure due to the infection of emotion.

Another great example of why we must follow our processes came from a recent trade I made within one of the models we have at my firm. I’ve blocked out the company name and ticker symbol because I don’t want you to get bogged down with what stock it is but focus more on the practical principle at hand.

Let me begin by saying that not all positions and trades at my firm are short-term. We’ve held some stocks for 6+ years (with varying degrees of exposure at different times). However, the position I’m using as an example today was something that only got held for a little over two months. It was a stock that had recently broken out to a new high but then began to consolidate with a series of slightly lower highs. I began watching for support around $32.75 as my exit point,which lines up with prior consolidation lows and near the breakout point. This stock broke support on October 25th after several failed attempts to break above its 50-day Moving Average.

So at this point we had a stock that’s turned support into resistance (with respect to the 50-MA), made a series of lower highs, and has broken support. This met my sell criteria and the position was exited. This isn’t a trade that turned into a 10-bagger like many on social media like to selectively share.  But what did ultimately happen, was it fell 20% in the two days after I exited. I of course had no idea it would decline by that much but I am thankful for the ability to follow a process and protect my firm’s clients capital. It’s important to recognize what the market’s trying to tell you. For this stock, it was that things were beginning to break down. While it was surprising to see the stock sell-off as hard as it did after we sold, I’m not overly shocked that it saw weakness – because that’s what the chart was telling us – price action is weakening.

follow-process

So much focus gets put towards when to buy something and I get why. That’s the fun part, that’s the flashy adrenaline pumping part of trading. What’s more fun, buying a new car or selling your old one? Of course buying new! But guess what, (in most people’s cases) you can’t buy a new car unless you’ve sold your current one and the same applies to stocks. We have only so much room in a portfolio, our attention can’t be solely on searching for new shiny stocks to buy. We must also monitor what we currently own and hone in our skills on when to sell.

Let me end by saying, yes this is a cherry-picked example. Not all stocks we sell drop like a rock once the sell order is executed. I do not write this post to pound my chest but to provide an example of the positive outcome that can be produced when you stick to your guns and follow your process. So often we see articles and blog posts written on successes had from a stock quadrupling but a success in trading isn’t defined by just how much money is made but also how much is also not lost.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.