Keep This XLF Chart Pattern on Your Radar

The financial ETF is floundering after a breach of its 200-day moving average

by Bernie Schaeffer

Published on Jun 26, 2018 at 7:34 AM
Updated on Jun 26, 2018 at 7:34 AM

Almost directly on the heels of a wave of financial media headlines touting the strong prospects for bank stocks as the Fed gradually hikes rates, investors seem to have all but abandoned the sector. The latest Bank of America-Merrill Lynch update on Friday tallied $1.4 billion in outflows for financial stocks over the previous week, representing the largest outpouring of funds since September 2016.

Indeed, in the five trading days ended June 20, the Financial Select Sector SPDR Fund (XLF) registered $1.15 billion in outflows, per data from etf.com. Over this same time frame, XLF shares broke below prior support at their 200-day moving average -- and the fund has now collected six consecutive daily closes below this trendline, which showed every indication that it would switch roles to act as resistance when it was tested by XLF during last Wednesday's intraday action.

The XLF drop below its 200-day was the latest stumble in an ongoing downtrend from the fund's late-January peak just north of $30, as the shares have formed a series of lower highs since then. However, the $26.50-$27 neighborhood has reliably contained XLF's lows in 2018. The resulting descending triangle pattern most often has bearish implications, suggesting a reversal of the longer-term XLF uptrend is taking shape.

Against this backdrop, note also that put open interest on XLF is remarkably low at the moment. Call open interest remains fairly robust (2.1 million contracts in open interest, which Trade-Alert pegs in the 71st annual percentile), and has been climbing consistently since the post-expiration decline in mid-June. Conversely, XLF put open interest languished near its post-expiration lows over the last week, arriving Friday at 1.6 million contracts -- an accumulation that ranks below 95% of other daily readings from the past year.

Normally, such a pronounced lack of put open interest on an underperforming stock would raise red flags from a contrarian perspective, as it would signal a general lack of interest from bears. In the case of a broad, sector-based exchange-traded fund (ETF) like XLF, the "red flag" is an apparent lack of buying interest from hedge funds and other deep-pocketed players, who often purchase sector ETF puts to hedge their long equity exposure as they accumulate shares. As such, the extremely thin supply of put open interest on XLF implies that money managers have very little in the way of bank stock exposure to hedge -- and the stagnation in put open interest of late indicates that they don't appear to be accumulating new shares at the moment (and are more likely, per the outflows data referenced above, to be in distribution mode).

That said, XLF call open interest has consistently outnumbered put open interest since mid-April -- the longest such stretch in years. So bear in mind that the above-described concern regarding a lack of accumulation by money managers is not necessarily a new development, but instead part of an ongoing trend (which, like so many other stock market trends, will eventually reach its peak and revert to a more "normal" situation). But given that XLF's January peak was a decade-plus high, it may well take more than a couple months for this scenario to play out fully.

With all of this in mind, keep a close eye on that XLF triangle pattern. Investors have already opted against buying the pullback to the benchmark 200-day moving average -- and an unwillingness to defend the lower rail of this triangle, which lies along the same lines as XLF's October-November 2017 highs, would signal a strong likelihood of greater losses for the bank sector.

xlf descending triangle chart


Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, June 24.

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