The Two Signals That Will Determine This Sector’s Rally

One of the fundamental changes in the market in late 2022 was the rotation into “old economy” stocks…

That huge inflow of money propelled the Dow Jones Index to its best monthly performance in almost 50 years.

And we saw companies that supply industrial conglomerates enjoy a massive boom as well.

When we checked in on the Materials Select Sector Fund ETF (XLB) in December (red arrow on the chart below), we saw how it had rallied 25% from its October lows.

XLB then went through a pullback before rallying again at the start of 2023.

With that rally now hanging in the balance, today I’m going to talk about what to expect from here…

Rallied Out of Oversold Territory

In the chart of XLB below, you can see how it held up well at the start of the year. Its April peak (B) was less than a dollar below its January high (A).

But as the 50-day moving average (MA – blue line) shows, it started trending down after June. Take a look…

Materials Select Sector SPDR Fund (XLB)

Source: eSignal

The lower high in June (C) was bearishly followed by another lower high in August (D).

Each of the down moves that followed these peaks coincided with two key bearish signals…

1. The 10-day MA (red line) crossed below the 50-day MA and then started to accelerate lower.

2. The Relative Strength Index (RSI) broke down through support (green line) and then remained stuck in the lower half of its range (until the counter-rally up to the next peak).

As the chart shows, XLB finally found a base in September through October (upper red line) when the RSI formed a ‘V’ and rallied higher out of oversold territory (lower red line).

And when buying momentum steadily increases like this, eventually the stock will turn higher too.

XLB’s rally then began to gather pace. The RSI broke back up through resistance and into its upper band…

Adding confirmation to that up move, the 10-day MA then broke back above the 50-day MA.

Take another look…

Materials Select Sector SPDR Fund (XLB)

Source: eSignal

But when we looked at XLB on December 13, I noted that an unfolding pattern was warning us of a potential reversal…

While XLB was making higher highs (upper orange line), the RSI was making lower highs (lower orange line).

And that’s exactly how things played out…

With the RSI tracking lower and then down through support, XLB retraced from its highs.

After a brief period of consolidating just below resistance (red circle), the RSI then broke back into its upper range early this month.

And in another bullish sign, the 10-day MA has also broken back above the 50-day MA.

So what am I looking for next?

Watch Out for Any Sharp Reversal

For XLB’s rally to continue, the RSI must retain its foothold in the upper half of its range. The longer it can stay there without a sharp reversal, the longer any rally could be.

I’ll also be keeping a close watch on our MAs…

As the chart shows, the 10-day MA has only recently broken back above the 50-day MA.

From here, we’ll want to see the 50-day MA continue to track higher with the 10-day MA accelerating above it for any confirmation of XLB’s potential next up leg.

However, the 10-day MA pattern also warns us of how volatile XLB can be…

Should the RSI reverse sharply and break support, then XLB could retrace just as quickly.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

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