XLY SPDR Nearing End of Weekly Corrective Pattern

The Consumer Discretionary sector thrives when the overall US economy shows marked strength.  With wage growth on the rise, consumer confidence on the rise, unemployment on the decline, a strong US dollar reducing the cost of imported goods, and the GDP showing increasing strength, it's hard to argue that the overall economy is anything but robust.  All of this bodes very well for the Consumer Discretionary Select Sector SPDR Fund (NYSE: XLY). 

XLY Weekly Chart

As we can see on the weekly chart, XLY began a healthy recovery in October 2011.  With only minor sub-wave paused in 2012 and 2014, the sector SPDR rose steadily until Wave-1 peaked in August 2015.  What followed was 18-months of corrective action starting with an A-B-C flat that ended in February 2016.  Now, the question before us is if the corrective pattern is an X-Y-Z triple, or if we have just completed the second set of a double correction.

It's the latter that I show on the weekly chart, marking Wave-2 complete at the end of October, 2016.  That's by no means certain, however, as we'll see when we review the daily chart.  So as far as the weekly is concerned, we have either completed Wave-2 and are now starting what should be a towering Wave-3 (remember, Wave-1 ran for 48 points,) or we are into the third and final A-B-C corrective pattern in a larger X-Y-Z pattern.

On the weekly, neither the On Balance Volume, which remains flat, nor the RSI(9) offer strong clues as to our next direction.  We're trading in a well defined bullish channel, which implies offers strong support for a shallow last corrective wave if that occurs, and we're currently trading above a relatively strong support line, so at least on the weekly there's evidence that the next impulse may be in flight.  Let's look at the Daily Chart, however, for more details.

XLY Daily Chart

We'll look first at the trend lines.  The pattern starting with Wave-X shows an upward sloping (albeit at a shallow slope) bull channel with three touches at resistance and two touches at support.  Since the second Wave-C completed (which may possibly be Wave-Y) price has hovered above the mid-point of that channel.  In fact, a three-touch trend-line with a steep slope formed from the second Wave-C and may offer some support for a subsequent pull-back.  Anyway, from a trend line perspective, our direction is up.

Looking next at horizontal support and resistance, there's a strong support line at $82.  This line served as strong resistance across much of the chart before it was breached in late November, 2016.  The line was tested twice and it held both times.  That's another bullish sign.

On Balance Volume on the daily chart is rising, indicating that some accumulation is underway.  That's another good indicator, especially when we look at the volume pattern itself and see the relative strength of demand (black bars) compared to supply (red bars.)  Volume suggests that there's more demand at current levels, and that should push price higher.

There are two warning signs, however.  First, the highs of 13 December 2016 and 17 January 2017 form a double top.  The neckline only represents a 4% drop, however, so it's not a significant concern - the standard measure for a double top is a 10% drop to the neckline - but we do need to watch for a potential drop down as low as $78 for a short-term A-B-C Zig-Zag correction.  That would be consistent with an X-Y-Z correction, and if that does occur it will be an excellent entry point to ride the crest of the ensuing Wave-3.

Second, the RSI(9) oscillator on the daily chart is showing a bearish divergence on both the highs and the lows.  That signals subsequent weakness and a potential decline on the daily.  This would be consistent with the possible move south off the double top, and it would also be consistent with the final leg of an X-Y-Z correction.

How we'll play this depends on what the stock chooses to show.  Wave-3 has a potential run of 48 points or more, so there's no need to be hasty on the entry.  To enter long, we'll wait for a strong bullish move on confirming volume.  We'd prefer to see price break above the double top highs on convincing volume.  That would indicate that Wave-3 has, indeed, begun and we can enter with relative safety.

On the other hand, we're definitely not averse to playing that double top if we see strength to the downside.  Some caution is justified around the steep support line in purple, and again at the horizontal support line just below it.  Be ready for a swift exit at those levels if the move fades, however if we do drop to the downside off that double-top pattern, there's greater likelihood that the move will be swift and powerful, ignoring at least the diagonal support line.  It's not strong enough to halt a decisive move.  So if we do break to the downside, we'll be ready to play that short, and then to enter long immediately on a strong bullish reversal pattern. 

Being a sector fund, XLY does not report quarterly earnings, and the next ex-dividend date is not expected before March.  There are economic reports that impact the sector, however, so do be cautious around next Thursday's Jobless Claims and New Home Sales reports.  The major movers for this sector, however, will come on Friday, 27 January with the GDP report, the Durable Goods Orders, and the Consumer Sentiments report.  Monday, 30 January will also be impactful with the release of the Personal Income and Outlays report.  Be cautious with an open position heading into each of those announcements.

Happy Trading.