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Chart Of The Day: Communication Services Headed Toward 2020 Bottom

Published 08/29/2022, 07:57 AM
Updated 07/09/2023, 06:31 AM
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XLU
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This is part two of a three-part top-down analysis. On Thursday, I analyzed the S&P 500 Index, and in today's post, I will examine a sector in that index as I refine down to find the best, or in this case, worst asset.

The Communication Services sector (NYSE:XLC) is down 29% while the Utilities sector (NYSE:XLU) hit an all-time high on August 19.

So is XLU more likely to keep hitting new all-time highs or is XLC more likely to register new lows?

Well, in previous bear markets—2000, 2008, and 2020—the defensive sector also dropped. Therefore, I think in a crash, Utilities will fall if Communication Services continues to slide.

But which of the two is more likely to fall more?

The Technology sector split into Technology and Communication Services in September 2018. Therefore, we only have data for the XLC in the 2020 bear markets. We'll have to use the Technology Select (NYSE:XLK) sector for the two earlier bear markets.

I measured the following price changes monthly from peak to trough on the monthly chart.

XLU

  • 2000 -56.87%
  • 2008 -44.55%
  • 2020 -38.91%

XLC/XLK

  • 2000 -82.58%
  • 2008 -54.76%
  • 2020 -33.84%

So, we discover that Communication Services/Technology stocks underperformed Utilities in the first two crashes but outperformed them in the COVID-19 crash. So that's Utilities 2 : Technology 1.

On the other hand, the 2000 crash was when the technology bubble burst so maybe the dotcom crash is not representative. Perhaps it was a once-off and investors acted prematurely overestimating how quickly the sector would become profitable (Sound familiar? Cryptocurrency?). So that's Utilities 1 : Technology 1.

But, we can do the same thing in reverse. The only reason Technology outperformed Utilities in the 2020 bear market is that it outperformed all sectors during the COVID-19 global lockdown.

Our quest is to determine which sector will underperform in a typical environment.

The very reason that the Global Industry Classification Standard split the Technology index into Technology and Communications Services was because of the impact of the FAANG stocks on the sector. Just like internet stocks drove the dotcom bubble, social network stocks have been driving the bubble in the last few years.

XLC Daily

In three sessions, XLC fell below its rising channel for the second time. Last time it climbed back up. Will it do so again?

Judging by the MACD, it seems not, but the RSI offers a possibility for a rebound.

In the final analysis, the volume diminished with the recent rallies and spiked with the declines, demonstrating that the force is with the bears. Unlike other sectors, the XLC did not come close to its 200 DMA but found resistance by the 100 DMA and closed Friday below the 50 DMA, again, for the second time in three sessions.

But we must warn that the sector has been trading in an H&S bottom pattern since May. If it closes above $60, it will have bottomed, forcing me to change my position.

However, as long as the trend is intact my opinion remains.

Trading Strategies

Conservative traders should wait for a new low to confirm the downtrend and blow out the H&S potential.

Moderate traders could risk a short when the price clears the rising channel since the mid-June low, then returns and confirms the resistance of the falling channel since the September 2021 all-time high, or at least that of the broken short-term rising channel.

Aggressive traders could short the rally that would follow, clearing the rising channel.

Trade Sample - Aggressive Short

  • Entry: $57
  • Stop-Loss: $60
  • Risk: $3
  • Target: $45
  • Reward: $12
  • Risk-Reward Ratio: 1:4

Disclaimer: The author currently does not own any of the securities mentioned in this article.

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