(Premium) Communication Services Sector Deep Dive - October
The Communication Services sector was on a roll.
Most of the equity market peaked in late July and sold off throughout the months of August and September. Communications, meanwhile, continued to hover near its highs, up more than 40% for the year. October was more of the same, with the sector even managing to touch new 52-week highs on the 11th.
Then came earnings season.
Earlier this week, Alphabet reported results for its cloud business that disappointed the street. The stock dropped 9.5% on the news, its worst 1-day performance since the middle of the COVID collapse in March 2020. And since Alphabet is the largest component of the sector, its weakness drove a nearly 6% decline in the price of Communication Services overall.
The selloff acts as confirmation of a bearish momentum divergence that we've been eying for weeks. Although the sector has been trekking steadily higher all year, RSI peaked all the way back in June and hadn't even reached overbought territory since then. That divergence implied a lack of outright control for the bulls - and it was happening near the 61.8% retracement of the entire 2021-2022 decline. Still, with the sector continuing to rise and show relative strength, waiting for price action to confirm the momentum weakness was the best move. Now that it has, Communications is best left alone as it digests the year-to-date gains.
Structurally, the group is still in a relative uptrend versus the rest of the index. The 2018 lows are the line in the sand. We wouldn't be surprised to see the ratio backtest its breakout above that key rotational level, but we definitely don't want to see break back below. If we do, it'll be best to approach this sector from the underweight side, rather than the neutral side.
We'd be more bullishly inclined if we see the strength beneath the surface. Most of this year's sector outperformance has been driven by the mega caps (GOOGL, META, NFLX). Meanwhile, the equally weighted sector peaked against the equally weighted S&P 500 back in February. A breakout would catch our eye.