XLG: A February-March Pullback Expected After An Incredible Rally (NYSEARCA:XLG)

Large-cap stocks have had a heck of a run. Since the October 2023 low, the S&P 500 is up more than 20% and higher in 13 of the past 14 weeks. It begs the question: Have we come too far, too fast? Is a February and March pullback in store? History suggests that it’s quite possible. According to data collected by technician Steve Deppe, CMT, this situation has happened seven times previously. Over the ensuing four weeks, the SPX has been lower each time, losing 2.2% on average.

Given weak seasonal trends and what looks like an exhaustive rally late last week, I’m issuing a near-term sell rating on the Invesco S&P 500 Top 50 ETF (NYSEARCA:XLG). The tech-heavy fund has robust momentum, but conditions appear overbought. I previously had a hold rating on the fund in Q3 2023 and outlined a ‘buy the dip’ strategy at the $33 level (split adjusted) which worked out to a T.

Steve Deppe, CMT: Data Show Bearish Trends After Monster Large-Cap Rallies

JC Parets, CMT, also highlights the declining number of S&P 500 stocks trading above their respective 50-day moving averages while price makes new highs – a bearish divergence.

According to the issuer, XLG is based on the S&P 500 Top 50 Index and the fund will invest at least 90% of its total assets in securities that comprise that index. The index is composed of 50 of the largest companies in the S&P 500. The ETF and the index are rebalanced annually.

Ranked No. 1 in its Sub Class by Seeking Alpha’s ETF Grades, XLG is a moderately-sized fund with slightly more than $3.4 billion in assets under management as of February 2, 2024. The portfolio pays a small 0.69% trailing 12-month dividend yield while its annual expense ratio is modest at 0.20%. Share-price momentum is remarkably high right now following the meteoric rise among megacaps over the past 14 weeks.

Risk metrics are also robust given muted drawdowns lately, though the fund is not all that diversified despite holding many blue-chip domestic companies. Finally, liquidity scores are strong given XLG’s average daily trading volume of more than 800,000 shares over the past three months and XLG’s 30-day median bid/ask spread of just three basis points, per Invesco.

Digging into the portfolio, the 5-star, Bronze-rated fund by Morningstar plots along the top row of the style box. Almost two-thirds of the allocation is considered large-cap growth. So, there is not much style or size diversification. That has worked out well in recent years given the tech-led market rally which has left SMID caps and some value companies lagging. What’s more, with a price-to-earnings ratio north of 23, the fund does not come cheaply, though long-term earnings growth is impressive.

XLG: Portfolio & Factor Profiles

With superb momentum and a low cost, there are certainly positive aspects to XLG. What concerns me, though, is that more than 40% of the ETF is positioned in the Information Technology sector with another 14% in the tech-related Communication Services space. Thus, XLG is an active bet that those sector bull markets will persist. Given the data described at the onset of the article, I fear a pullback is in the cards.

XLG: Holdings & Dividend Information

Seasonally, February and March are lukewarm months for XLG, too. The past 10 years have witnessed muted gains starting about right now, and mid-February through mid-March has been a period of particularly volatile events.

XLG Seasonality: Weak From Mid-February Through Mid/Late March

The Technical Take

Now, if you simply look at the chart, a clean breakout is what you will find. Notice in the graph below that shares moved through key resistance at the January 2022 peak in the $37 to $38 range. With XLG now above $40, it will be key for the fund to hold that previous high-water mark. The ETF tagged its rising long-term 200-day moving average in October 2023 before zooming higher – a fast 25% rally. About $5 above its 200dma today, digestion of recent gains would be healthy, in my technical eyes.

Also, take a look at the RSI momentum oscillator at the top of the graph. It is near technical overbought territory, and a modest bearish divergence is in play right now – the bulls would like to see a new high in the RSI gauge to confirm the rally in the share price. A 10% pullback would absolutely make sense to me, with XLG potentially falling into key support and a high area of volume by price in the mid to high $30s. A bullish point I must acknowledge to readers is that overall volume has been on the rise since late in Q3 last year – that tells me big money has been entering the fund, a bullish signature.

Overall, there are mixed signals, but there is no doubt that a powerful uptrend has been underway for the last 16 months with XLG.

XLG: Bullish Breakout, But Shares Stretched Relative to the 200dma

The Bottom Line

I have a near-term sell rating on XLG. History shows that rallies comparable to what we have enjoyed since October tend to see consolidations with downward price action. With weak seasonal trends on the horizon, it would make sense to take profits in XLG today in my opinion.