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Seasonality Prefers Health Care over Financials in June


In this week's episode of Sector Spotlight (Tuesday 10.30-11.00am ET), I ran out of time to review outstanding pair-trades so I am writing them up here in this article.

Monitoring (pair trade) ideas and how to properly communicate and track them remains an ongoing concern. Let me point out that the whole exercise of coming up with (pair) trade ideas is educational in nature and in no way, shape or form should be used as investment advice. It is NOT!

What it is is a way to put certain technical observations into more tangible ideas. However, the implementation of such ideas in a specific portfolio for a specific individual will vary greatly, as people have different investment horizons, different styles, different risk appetite, different restrictions, etc., etc. And different financial instruments can be used to create the desired exposure.

Recap

Since the last update/review in Sector Spotlight, I started to maintain the ideas in a group of longs and a group of shorts instead of 1-1 pairs. That resulted in two open long and two open short ideas that are still open.

SPY - IEV

This idea was launched based on the observation that, on the Relative Rotation Graph for international stock markets, IEV started to move into the lagging quadrant compared to SPY, suggesting a stronger US market compared to Europe.

Here is the current RRG for international stock markets:

The tail for Europe started to move up on the JdK RS-Momentum scale, so, at least for the time being, this underperformance seems to have run its course for now. Time to say goodbye.

However, new candidates for short positions against SPY are emerging. The two most obvious ones with the longest way to go, from an RRG perspective, are Hong Kong and China.

Looking at the charts, my judgement is that Hong Kong ($HSI) is more vulnerable to the downside than China, so I am going to replace IEV with EWH.Please note and be aware that I am using the indexes ($HSI) for my analysis on RRG and on the chart, but use EWH, which is the ETF that tracks Hong Kong, as the investable/tradable instrument. There can, and will, be a difference in their performance, firstly because the underlying index for EWH is the MSCI Hong Kong index and not the Hang Seng ($HSI) and secondly because EWH is quoted in USD and not in HKD. As long as you are aware of these characteristics, it will serve the purpose well.

XLC - XLF

This idea came from the analysis of seasonality and RRG at the start of May, when the expected seasonal performance for Communication Services and Financials was aligning with the rotation of the tails on RRG for those sectors at that time.

Here is the seasonal outlook for the month of June:

The most outspoken values for June are found for Health Care (70%) and Technology (30%). On the positive side, Utilities and Health Care are close to 60%, while Financials and Industrials and Discretionary remain weak at 35% and 40%.

The RRG below shows the tails for these sectors:

Technology - XLK

XLK is a mixed bag. Seasonality suggests a weak month for the sector, but it is one of the highest-ranked sectors based on RS-Ratio and the price is nearing all time high levels. So no alignment here. With price testing resistance at the top of the gap area, we may see the sector come off a little bit, but all in all it remains a strong sector.

Health Care - XLV

For XLV, which, by the way, is at pretty much the exact same location as XLK on the RRG above, seasonality suggests a strong month. This sector also is nearing all-time high levels but struggling with overhead resistance in relative strength vs SPY.

The high ranking on the RS-Ratio scale, combined with strong seasonality and a strong price chart, make XLV a candidate for the long basket.

Communication Services - XLC

XLC is still inside the leading quadrant and traveling at a positive RRG-Heading.

With a continued strong seasonal outlook and a strong price chart, there is no reason to remove XLC from the long basket yet.

Financials - XLF

Seasonality suggests continued weakness for XLF going into June. With price coming up to resistance offered by the gap area and a weak RS-Line, the sector can remain in the short basket.

Summary

All in all, this means the following changes:

Remove IEV from Long basketAdd EWH to Long basketAdd XLV to Long basket

#StaySafe,

--Julius


Original author: Julius de Kempenaer
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