The New Paradigm (For Now)

A new pecking order is emerging for sectors:

• Long utilities, airlines and consumer discretionary
• Short emerging markets, coal and metals

This might sound strange coming from me, given that I have mercilessly beat the drum on how low rates in the U.S. would drive capital overseas and condemn us to a Bernanke-induced deflationary coma. I still have those concerns over the longer term, but that trade has run its course for the time being. Right now, the trade is: "America First."

The reason is that nothing is always true in finance, so you can't bet that overseas assets will always outperform the U.S. Relative strength suggests the tide is shifting:

(All data through Friday’s close.)

EEM stands for the iShares MSCI Emerging-Market exchange-traded fund, which is clearly losing momentum vis-à-vis the S&P 500. This first caught my attention over at optionMONSTER when I noticed someone placing a large short position on the fund.

This makes sense when you consider what’s happening on the foreign-exchange charts, where the euro is collapsing and the greenback is rallying. November’s better-than-expected payroll report and last week’s strong retail-sales data confirm the U.S. economy is recovering. The market will now start betting on higher rates at some point down the road. (I think they’ll be disappointed because the Fed’s only concern is to keep its shareholders -- the banks -- alive. But, it will take people a while to figure that out.)

Euro/USD: Toast

Soure: fxstreet.com

Problems with the chart:

• Uptrend broken
• Bearish divergence before failure
• Failure at key $1.50 level

This rotation has been in place since mid-November, and is impacting the performance of different sectors:

(Note: I used EEM for emerging markets, KOL for coal, XLU for utilities and FAA for airlines. Green indicates outperformance versus the S&P 500.)

Utilities finally make sense again. Not only will economic recovery in the U.S. mean increased revenue for them. They also stand to benefit from the fact that corporate bonds are no longer as attractive to individual investors as they were a year ago. Most corporates are trading back over par and yielding less than 7%, so income investors must return to the tried-and-true utility space.

By the way, if you’re looking for real income, consider buying Annaly Capital Management (NLY) in an IRA or Roth IRA account. Because it pays unqualified dividends, it yields a hefty 15%. Owning it in a tax-free account lets you evade Tim Geithner’s grubby little fingers completely. However, watch out when the Fed raises rates or the yield curve flattens, because Annaly will get crushed.

Airlines are possibly the best place to be right now, and have been lighting up our Heat Seeker program at optionMONSTER. The first reason is that they are historically underowned because of their track record of losing money almost every year. The second reason is that their fundamentals are poised to improve in a big way thanks to capacity reductions and better pricing trends. Fares have yet to officially increase because carriers keep them low to appear high on searches. But their ability to charge more for sodas and checked bags now will translate into higher fares later. The trend supports better pricing power.

Finally, airlines trade inversely to oil. And the oil chart looks like death. Next stop, $65, and then the onus will be on crude to hold its 200-day moving average, or $60 is next.

Given the way correlations work, a stronger U.S. economy translates into a weaker euro, which translates into cheaper oil. It also translates into more demand for travel. In other words, airlines will have their cake and eat it too. (My personal pick is Delta Air Lines.)

Finally, when you consider corporations’ almost infinite ability to squeeze profits out of their cost structures, I think we’re going to see a surge in earnings for businesses that will leave most investors’ heads spinning. That means companies will start hiring and loosening up the purse strings on travel budgets.

In late November, I said it was time for the market to consolidate at the 500-day moving average, and I was right. However, I was wrong about how it would happen. I expected the euro and oil to pull back more quickly and then rebound. Instead, we’re seeing a rotation into sectors such as utilities, plus continued strength in consumer discretionary, healthcare and industrials. Meanwhile, financials and weak-dollar names are getting hurt.

There are a couple more implications to these trends.

First, avoid the coal trade. I have been a bull on this sector for a while, but it’s closely correlated to emerging markets. Furthermore, the chart of Joy Global (JOYG) is flashing warning signs:

Joy Global: Bears Taking Charge?

Reasons not to own this stock:

• Waning volume and momentum
• Double top at $59.30
• Consolidating below 30- and 50-day moving averages

Another reason not to like coal is that the inventories of the stuff are gargantuan. Despite all the hot air about Chinese demand, no one has explained to me why U.S. stockpiles are more than 30% above their levels this time last year. You can see this with your own eyes if you live near Baltimore, where it’s piled up like a mountain at the depot. Furthermore, weakness in oil can’t be good for coal.

U.S. Coal Inventories

Source: EIA Weekly coal report

Along with that trade, it’s time to rotate out of railroads, which tend to follow coal. The place to be in the transport space now is in the airlines. We’ve also been seeing call buying in trucking names.

Secondly, there might be one overseas market worth owning: Japan. Fast Money’s Joe Terranova, who I disagreed with in my last column, made an interesting observation on Friday’s show.

"I think it’s a strategic shift going into 2010," Terranova said, observing that stocks are now going up despite dollar strength. "You’re starting to see the yen ... become the funding currency once again that it once was when the dollar took its place."

Sure enough, USD / JPY is showing signs it might be ready to reverse higher (meaning the yen will weaken):

USD / JPY: Ready to reverse?

Source: fxstreet.com

Just as a strong dollar hurt stocks last year and a strong yen has been bad for the Nikkei, a return to the old “sell the yen” trade will be bullish for Japanese stocks. Maybe that’s why the EWJ exchange-traded fund has gained 4.8% in the past month while the S&P is only up 1.8%. Over the past three months, the S&P 500 climbed 6% while the EWJ is down 3%, so once again we’re seeing a shift in relative strength in the near term. (Given the demand for Toyota vehicles in the “cash for clunkers” program, TM could be the name to own.)

Finally, I do believe the longer-term trend remains in favor the weak dollar and supports gold. But it can take extended pauses before continuing. The main reason is to like gold over the long-run is that it’s still massively underowned. A century ago, the average person owned gold. Today, many multimillionaires have none aside from their jewelry. I consider the past 70 years of fiat currency to be a deviation from the long-term trend. Commodity guru Jim Rogers made a similar observation in a wonderful interview recently on CNBC, when he said most money managers had never owned gold. I think that simply by reverting to the way things worked since antiquity, gold has to move a lot higher -- far higher than I care to guess. It might be a “barbarous metal,” but who says we’re civilized?

DISCLOSURE: I OWN NLY, DAL