Will Chart Setup Drive This Sector Higher?
From several chart angles, the auto parts space looks like a good risk/reward setup presently.
One hallmark of the bull market in U.S. equities over the past 12 months has been the continual emergence of new groups with favorable technical setups. Call it rotation or whatever, there has been no shortage of positive-looking charts at any given time. Even now, well into the rally, we continue to see new groups pop up to provide good risk/reward setups for entry into this market. One such group presently is the auto parts sector.
Looking at the chart of the Dow Jones U.S. Auto Parts Index, we see 2 potential interpretations -- both very bullish (and both could be relevant simultaneously):
One is a potential cup-&-handle since 2015. Once again, the 2 parts generally show the following characteristics:
The Cup: This phase includes an initial high on the left side of a chart (e.g., the May-June 2015 high around $470), followed by a relatively long, often-rounded retrenchment before a return (e.g., March 2017) to the initial high.
The Handle: This phase involves a shorter, shallower dip and subsequent recovery to the prior highs (e.g., the March-May 2017 period here).
The bullish theory is predicated on the idea that after taking a long time for a stock to return to its initial high during the “cup” phase, the “handle” phase is much briefer and shallower. This theoretically indicates an increased eagerness on the part of investors to buy the stock since they did not allow it to pull back nearly as long or as deep as occurred in the cup phase. Regardless of the theory, the chart pattern has often been effective in forecasting an eventual breakout and advance above the former highs.
The other potential interpretation is an inverse head-&-shoulders pattern. This pattern consists of a major low (head), e.g., in February 2016, flanked by 2 higher, proximate lows, e.g., the shoulders. In this case, the left shoulder(s) were in August-September 2015 while the right shoulders were marked by June and October 2016. The neckline is represented by the tops established within the period of the pattern (the same as the top of the cup-&-handle). Once that neckline is cleared, prices have the potential to shoot significantly higher.
Most importantly, in the past few days, we’ve seen prices move above the tops of those 2 potential patterns, seemingly confirming a breakout of the 2 patterns and suggesting substantial further upside.
Prices are also currently obliging investors by retreating to challenge the breakout level around 470. From a risk/reward standpoint, this is the best possible time to enter into a position from the long side. That is because a decisive move back below the breakout area would suggest a false breakout and should trigger a stop out on any long positions. That is, if prices move decisively back below the former highs, a false breakout is a strong possibility and one would be well served by “getting out”.
While there are no auto part funds that we know of, in a premium post at The Lyons Share, we take a look at some of the better positioned auto parts stocks, from a technical perspective, with which to take advantage of this potential opportunity.
If you want this “all-access” version of our charts and research, we invite you to check out our new service, The Lyons Share.
Disclaimer: JLFMI’s actual investment decisions are based on our proprietary models. The conclusions based on the study in this letter may or may not be consistent with JLFMI’s actual investment posture at any given time. Additionally, the commentary provided here is for informational purposes only and should not be taken as a recommendation to invest in any specific securities or according to any specific methodologies. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.
