Earlier this week, we talked about the Quads – a powerful tracking tool that actually follows money in and out of stock market sectors.

The Fed doesn’t make it easy to get to the truth; they’d rather we all bought the feel-good, altogether fake picture they’re selling amid the mother of all market melt-ups. But, as my colleague Tom showed us, the Quads are the perfect way to easily identify real relative weakness and strength in the market, even down to individual stocks.

As Tom says, the Tech sector as a whole is relatively strong right now; money is still flowing in. But as he’ll show you in a second, not every tech stock is benefitting equally and some are unquestionably better buys right now.

Let’s turn it over to Tom and dive in…

Here’s a Look Deep Inside This Week’s Heat Map

We’ve “enhanced” the heat map today. Earlier, we saw the oh-so-popular tech sector, as tracked by the Technology Select Sector SPDR ETF (NYSEArca: XLK) in Quad 2.

But today, in this enhanced version, Quad 2 contains all the stocks underlying the XLK ETF, so we can get the real story. Because just as broad sectors move relative to other sectors in strength and weakness, so too do the individual stocks within a given sector move. That is, the principles behind our Heat Map work not only for broad sectors, but also for the stocks which comprise them.

As always, some stocks are hot, some are not. This means it’s not enough to identify the leading sectors-one must also drill down and locate which stocks within those winning sectors are worth trading.

This may surprise you. Let’s talk about what’s going on specifically within the leading technology sector and why it’s important…

 

First, take a look at those rate-of return (ROR) boxes atop each Quad – these reflect the average 30-day return of all of the stocks included in each Quad.

For example, the Quad 1 ROR (where we plot developing strength) is up 8.36% for the past 30-days. Nothing shabby about that.

Quad 2 (our strong “green light” Quad) delivered a 12.22% ROR, better yet.

Quad 3 (our weakening “yellow light” Quad) leapt forward, up 46.26%.

And, to be expected, our Quad 4 (our weakest “red light”” Quad) returned just 1.84% over the past 30-days of pure… and predictable… “QE-driven stimulus.”

You can see the full-circle and clockwise progression in ROR – from Quad 1 to Quad 4 – namely 8% to 12% to 46% and then back down to 2%. That’s just what we’d expect as stocks in the underlying Quads strengthen, top, weaken and then bottom.

Now, you may be asking yourselves: “Why is Quad 3, our weakening yellow Quad, pumping out the most gains?”

That’s because they’ve already made the long, clockwise journey from Quad 1 to Quad 2 and now to Quad 3 – and that takes time (weeks), adding to gains incrementally over the journey through each Quad.

Think of a baseball rising from the bat, sailing high over the pitcher and deep into center field. It takes time for that ball to launch, rise, peak and then eventually fall to earth.

Rising sectors and stocks make similar journeys, albeit with more daily gyrations than a rising baseball. But like a baseball, they move in an “arc.”

Once these well-performing stocks find themselves in Quad 3 (our yellow Quad), they are running out of speed and volume, which means TAKE CAUTION: This ball, having flown far and high, is coming back down to earth.

As you can plainly see. All Quads have quite a few stocks in them, but not all stocks are created equal.

Some are winners and some are losers. Some are homeruns, others foul balls.

So, when your broker suggests that “tech is hot,” that’s only half the picture. Sure, an investment in the Sector ETF may be warranted. ETF’s are diversified.

But if your broker is advising on individual stocks, make sure these recommendations are homework-based. Not all underlying tech stocks are worthy of investment. Remember, some are homeruns, others are strike outs.

Again, what we are trying to do here is pick the leading stocks in the leading sectors.

Here’s another analogy that may be helpful…

When shooting sporting clay pigeons, you don’t look down the barrel as you yell “pull” and then wait for the pigeon to just pause in front of your gun sight. Instead, you lead the clay.

Picking winning stocks in a particular ETF is no different-you have to gauge its trajectory before pulling a buy or sell trigger. In short, you have to lead within the ETF and shoot for those clays with the most relative strength as they begin their rising trajectory.

And when it comes to relative strength, we’d remind that there are two layers exhibited in the very first Heat Map above, namely ETF’s Quad-to-Quad (as we have described and colorfully-marked), but also (within each Quad) stocks are ranked opportunistically, top-to-bottom, strongest-to-weakest when it comes to relative strength.

That’s another feature we’ve “wired” into the Quads to make them as informative – and lucrative – as we possibly can.

Here’s a Closer Look at the Quads’ Top Stocks

Let’s take a quick look at the top individual stock in each of Quad’s 1, 2, 3 and 4 and see if we can confirm their Heat Map positioning-i.e. whether the pigeon is coming into gunsight range. These specific stocks are charted below:

 

 

Stepping through each plot:

  • Quad 1 – DXC Technology Co. (NYSE: DXC) – Light Green Line – Developing upward trend. Good.
  • Quad 2 – KLA Corp. (NASDAQ: KLAC) – Dark Green Line – Looking stellar! Great.
  • Quad 3 – Western Digital Corp. (NASDAQ: WDC) – Yellow Line – It’s been a nice ride, but time to take caution!
  • Quad 4 – Alliance Data Systems Corp. (NYSE: ADS) – Red Line – Forget it.

Et voilà! The proof is in the pudding. A plot of each top stock in each Quad is EXACTLY as we would expect – from strengthening, to topping, to weakening and falling Quads.

The Heat Map is an industry-leading tool for picking the leading stocks in the leading sectors, week after week after week.

You can now see that our system, however simplified above, gives us a clear pulse check on the markets, regardless of their direction-up, down, or sideways.

It’s simple: Locate top performing stocks in top-performing sectors for going long, and doing the same for weakening stocks in weakening sectors when it’s time to go short or get out.

That’s the kind of approach – backed by evidence, not adjectives – that makes (and keeps) money for readers following along with our recommendations.

We’re two steps ahead… and so are YOU. Next week, we’ll be looking at some of the other confirming signals necessary to make a trade – keep your eyes peeled.

But before we go…

Edouard O. asked whether we track the Dow Jones Transportation Average (TRAN) in our Heat Map. For the moment, the Heat Map is concentrated on SPDR Sector ETF’s, which you’re going to hear a lot about in the coming weeks.

That said, we can parse anything – this is a really powerful tool – and so we took a peek at the SPDR S&P Transportation ETF (NYSEArca: XTN). We like to look at the ETF as a proxy to TRAN because it reflects investor inflows & outflows, often a precursor to a change in trend.

Long story short, XTN is in Quad 2 (“Strong”), with a slight, but noticeable, turn towards weakness this week.

And we would add that flows into the ETF turned negative as far back as late August and have continued to deteriorate in spite of the rise in price. Volatility in the ETF is all wound-up. All in, we could see a downside correction in the cards.

Until next week, stay informed, stay calm and stay safe,

Matt Piepenburg and Tom Lott


Comments

4 responses to “How to Quickly Spot a Sector’s Best-Performing Stock Buys”

  1. Do you offer a subscription service that would allow me to access the complete Sector Quad information on a daily basis?

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