Traders Take Profits and Show Cautious Optimism

Major Moves

The strong recovery the S&P 500 experienced during the second half of the week has been a welcome relief to the bulls on Wall Street. It is also a signal that traders don't believe the tariff increases between the United States and China have been set in stone.

I've been fascinated watching not only how the S&P 500 itself has recovered but also how the individual sectors within the S&P 500 have recovered. The technology sector has been the strongest performer by far. The consumer discretionary sector is not too far behind. On the flip side, the financial sector has shown the weakest recovery, with the utilities sector barely outperforming it.

You can see the sector performance distribution on the hourly sector comparison chart below, which uses the following sector-based exchange-trade funds (ETFs) managed by State Street Global Advisors:

  • Technology Select Sector SPDR Fund (XLK)
  • Real Estate Select Sector SPDR Fund (XLRE)
  • Consumer Staples Select Sector SPDR Fund (XLP)
  • Consumer Discretionary Select Sector SPDR Fund (XLY)
  • Health Care Select Sector SPDR Fund (XLV)
  • Materials Select Sector SPDR Fund (XLB)
  • Utilities Select Sector SPDR Fund (XLU)
  • Energy Select Sector SPDR Fund (XLE)
  • Industrial Select Sector SPDR Fund (XLI)
  • Financial Select Sector SPDR Fund (XLF)

Seeing the technology sector perform so well is not surprising since it has been outperforming all other sectors throughout 2019. Stocks like Cisco Systems, Inc. (CSCO), Applied Materials, Inc. (AMAT) and Accenture PLC (ACN) have all had a great week.

Seeing the consumer discretionary sector doing well is also not surprising. For the past few days in the Chart Advisor, I've been talking about retail sales numbers coming in strong. These strong sales numbers are being reflected in the strength of the retail-based consumer discretionary stocks.

What has been interesting to see is just how much lower long-term Treasury yields have held financial stocks down. While they haven't dropped any farther during the second half of the week, stocks like Bank of America Corporation (BAC), The Goldman Sachs Group, Inc. (GS) and Citigroup Inc. (C) are all struggling with the potential of lower long-term yields pushing their net interest margin levels lower.

At the same time, lower long-term interest levels are failing to boost utilities stocks like they normally would. Typically, the lower long-term yields go, the more utilities stocks start to shine because their dividend yields become increasingly competitive. But that's not happening right now.

I think this is due, in large part, to trader sentiment. Traders are currently seeking out more aggressive stocks to put their money into because they believe the market is going to rally. If traders were less optimistic, they would most likely be looking to put more money into conservative stocks like utilities.

Performance of the S&P 500 ETF vs. sector ETFs

S&P 500

The S&P 500 was showing some great strength on Wednesday and Thursday, but today's gravestone doji may signal the end of the bounce. Gravestone dojis typically signal the end of a bullish run as traders attempt to push prices higher but are unable to hold onto those lofty levels and end up giving back most of their gains on the day.

If that is the case, and the short-term bullish bounce is over, the S&P 500 will have failed to fully recover the losses it experienced as traders took some profits off the table in the aftermath of the U.S. and Chinese tariff increases. Now, I'm not saying the S&P 500 is doomed to drop lower, but traders are certainly being cautious as they head into the weekend.

The important thing to remember is that a gravestone doji must be followed up by a bearish candlestick to be confirmed. We'll have to wait and see what happens on Monday.

Read more:

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Wall Street Slaps Sell Rating on S&P's Newest Stock Sector

Performance of the S&P 500 Index

Risk Indicators – Small-Cap Stocks

I know I said trader sentiment looks quite bullish in my sector-comparison comments above, but I am going to temper that bullish outlook ever so slightly here.

Traders don't only tend to put money into technology, consumer discretionary and other more aggressive stocks when they are bullish. They also tend to put money into small-cap stocks to take advantage of the growth potential they provide.

However, we are not seeing a move into small-cap stocks at the moment. You can see this by creating a relative-strength chart between the Russell 2000 (RUT) and the S&P 500 (SPX).

Small-cap stocks, like those that make up the RUT, tend to outperform when traders are confident and willing to take on more risk in the hope of achieving a greater return. On the other hand, large-cap stocks, like those that make up the SPX, tend to outperform when traders are less confident and aren't willing to take on as much risk.

The RUT/SPX relative strength chart highlights these shifts in sentiment by moving higher when small-cap stocks are outperforming and moving lower when large-cap stocks are outperforming.

This week, the RUT lost ground to the SPX again. You can see how the RUT/SPX relative strength chart has been dropping and closed at the support level the chart has hit twice before – once in late March and once in late April.

This tells me that traders are still confident that the stock market is going to climb in the short term, but they are taking a more cautious approach to their bullishness. While both positions are bullish, it's safer to invest in a slightly more aggressive large-cap stock than it is to invest in an extremely aggressive small-cap stock.

Read more:

How Do the Risks of Large-Cap Stocks Differ From the Risks of Small-Cap Stocks

Valuing Small-Cap Stocks

Buy High and Sell Low With Relative Strength

Performance of the Russell 2000 Index vs. the S&P 500 Index

Bottom Line – Ending the Week with Caution

Traders ended the week on a cautious note. They didn't panic and start selling, but they also didn't buy hard into the closing bell. Instead, they left all of the gains from Wednesday and Thursday while taking some of Friday's intra-day gains off the table.

But who can blame them? After all, who knows what new developments we might see coming out of China or President Trump's Twitter account this weekend?

Read more:

Stocks Seen Facing Endless Upheaval Amid Trade Politics

Penny Stock Firms Cash in on Bitcoin's Rise

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