This Market Is Running on Fumes

If you need a laugh for a second, the current situation surrounding the debt ceiling reminds me of a Seinfeld episode.  Remember the episode when Kramer test drives the Saab to find out how far he can go on an empty tank of gas?  That's what's going on with the market right now.

When it comes to the debt ceiling, the market's nerves are starting to run on fumes and we're actually in danger of the optimistic expectations that a deal had to be done could meet with the stark reality that it may not get done.  Not good.

But there's also a tectonic shift in the market that has nothing to do with the negotiations I'm watching with concern.  Here it is.

Over the last few weeks, we've seen the market focus all of its attention on technology.  Actually, not even technology... just A.I..  It's a dangerous play to jump into one area of the market so quickly, but that's what's happened.  We'll talk about that another time.

Here are just a few of the comments that I'm making on the sector shifts.

Let's dig into the materials sector...

Materials Select Sector SPDR Fund (XLB): Bearish

Think "Dr. Copper" here.  You know, the old rule that the demand and pricing for copper is an indicator for the economy.  Of course, copper is a material, but this sector also includes coal, steel, gold, aluminum, you get it.  If you build or manufacture with it it's a basic material.

Why is this a "tectonic shift"? This goes back to the Dr. Copper perspective.  

Demand for all of the things that I just listed out is dropping based on a global economic view.  We've seen Germany announce that they are in a recession.  The U.K. is on the same watch.  A growing number of people are saying the U.S. will avoid a recession, but you and I know differently.

Put all of that together and you've got a dimming outlook.  There are two more pieces of this puzzle though.  Technicals and sentiment.

The technicals of the basic materials sector are poor - at best.

Trading below its 20-month moving average, the XLB shares are in a technical bear market.  Add to that the fact that the 200-day moving average (MA200) is shifting into a declining pattern AND the 50-day moving average (MA50) is already declining below that same 200-day and you've got a poor technical trend.

Mark the technical bearish from a long and short-term perspective.

Now the sentiment side of the trade.  That's right... sentiment.

Remember that price is not a reflection of sentiment.  Instead, price movement is a result of sentiment.

Sentiment towards XLB has been optimistic.  Investors have been looking at the sector as one that is on hiatus instead of heading lower.  This is because of something I already mentioned, the sentiment that the economy will experience a "soft landing" or "no landing at all".

That "hope" indicates that the basic materials sector and companies have a lot of selling pressure at their current prices.  Think of it like potential energy.  The basic materials companies have a lot of potential energy in their current state.  Any catalyst - such as a signal that we are heading into that recession - will act to turn that potential energy into kinetic energy, causing momentum to the downside.

Summarize it all and you've got a sector that is in the process of potentially accelerating to the downside.  Here are the details as I see it.

XLB Critical Support: $75

XLB Overhead Resistance: $77

XLB Intermediate-term Target: $68

XLB Intermediate-term Target Move: 10%

How I'm trading it.

I'm using a little longer-term approach to this trend trade by using at-the-money September expiration put options.  That option is currently priced at -just under $3.00.

Using the price target of $68 and the assumption that the XLB hits that target before the half life of that option (about 50 days), the option would be worth $7.30 or better.  

Not a bad strategy for a hedge against the recession.


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About the Author

Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.

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