In our Sunday, Week Ahead post, we detailed how the Consumer Discretionary sector has been gaining on the Technology sector during 2021, providing superior results over a variety of timeframes year-to-date versus tech growth stocks. As the name indicates, consumer discretionary products are non-essential items shoppers tend to buy when they're feeling more financially flush.
Obviously, consumer discretionary stocks tend to do better amid economic growth. After a solid quarter signaled by earnings results during the current season, the US economy is indeed growing. Which is why Tech companies, whose growth shares are favored by investors during downturns, such as when COVID-19 lockdowns were in effect, are now lagging.
However, short interest, via the proxy Consumer Discretionary Select Sector SPDR® Fund (NYSE:XLY), is also growing. Last week it reached a nine-month high.
Pessimism on the sector appears to have been fueled by expectations that the global supply chain gridlock will persist and falling consumer sentiment amid the highest inflation in 30 years won't abate anytime soon despite the Fed's message to the contrary.
Technicals are telling a separate, yet interesting story that could provide confirmation for the shorts' expectations.
The ETF has been rising for the past four weeks, its longest winning streak since its nine-week rally which ended during August 2020.
Both the Stochastics and RSI are significantly overbought. The Stochastics' faster line fell below its slower line after the indicator soared to extreme overbought levels.
The RSI, too, reached an extreme overbought condition of 84, its highest since January 2018. The ETF dropped 11% afterward. Will it repeat the same pattern now?
We can't know, of course. However, we're uncomfortable with the repeated rising gaps, which increases the odds of a bearish indicator. An Exhaustion Gap is the most recent in a series of gaps. It occurs when a market is burned out after having moved too far, too fast.
Strengthening the case for Friday's price action to have formed an Exhaustion Gap is the fact that the price attempted to extend a rally but failed. Instead, the ETF closed at its opening price.
The bulls may have given it all they had, but the bears didn't allow the price to budge.
If XLY next falls deep into Thursday's price action, it will have developed an Evening Star. That is a 3-day reversal pattern, and that would confirm our bearishness right now on the ETF.
Beware, however that the trend is still up. We are attempting to catch a short-term reversal that may or may not have more extended consequences.
Trading Strategies
Conservative traders should avoid this trade, as it goes against the primary trend.
Moderate traders would wait for the long bearish candle to complete the Evening Star.
Aggressive traders could go short now, provided they accept the higher risk as a trade off for the greater returns they seek. Money management will determine their success, irrespective of this one trade's results.
Trade Sample
- Entry: $212
- Stop-Loss: $213
- Risk: $1
- Target: $207
- Reward: $5
- Risk:Reward Ratio: 1:5
Author's Note: We are not in the business of fortune-telling. No one knows the future. We are merely working the odds. Until you learn how to customize a trading plan, use ours for education, not for profit. Or you'll end up with neither. Guaranteed. And no money back.