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Sector Rotation Returns from February Bottom and Year-to-Date
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With the first quarter drawing swiftly to a close, let's pause a moment to look at the Sector Rotation Model - sector returns - from the February 5th market bottom and then further back to year to date, or Q1 2010.
First, let's start with the year to date chart to see where we've come and where the model might suggest we're going:
When looking at Sector Rotation, the first thing to do is segment the nine major sectors - represented here with the AMEX Sector SPDR ETFs - into two broad groups:
Offensive or Aggressive Sectors, which do well when investors are bullish on the market and economy and do best in expansions
Defensive or Conservative Sectors, which do well during bearish phases and during poor economic periods.
By comparing where the strength and weakness is, you can assess the best places to put your capital to work for a swing trading horizon, and also gather clues into what the larger funds think about the broader economy.
The Offensive Sectors are indicated with a green rectangle, and include Financials, Consumer Discretionary, Technology, Materials, and Industrials.
The Defensive Sectors are indicated with a red rectangle and include Consumer Staples, Health Care, and Utilities. No matter how bad the recession, you'll still need to brush your teeth, clean your house, buy medicine, and turn your power and water on (among other necessities).
That's why defensive sectors outperform (relatively) during downturns and are save havens for investors when the market waters get choppy - they rotate here for protection.
However, during strong times, investors will be out there spending their hard-earned dollars on entertainment, home accessories, travel, and other 'consumer discretionary' activities, while businesses and companies will be expanding and upgrading. That's why the aggressive sectors outperform in economic expansions.
So what is the model saying?
In the first Quarter, the offensive sectors far outperformed the defensive sectors, hinting that investors are confident in the future and that odds favor higher index prices yet to come, laying the foundation for a continuation of the rally.
The best sectors so far are the Financials (NYSE: XLF), Consumer Discretionary/Retail (NYSE: XLY), and Industrials (NYSE: XLI).
Not surprisingly, the worst (relative) performing sectors are the Defensive Sectors, namely Utilities (NYSE: XLU) which actually has a negative return so far for the year.
The one fly in the ointment is the Technology Sector (NYSE: XLK) as Google (Nasdaq: GOOG) has been a major drag on other technology companies after news it is pulling out of China's market.
This chart - with the exception of a low return in Technology - is exactly what you would want to see to expect further upside still ahead.
Let's now turn a bit more short-term to see the insides of the strong rally off the February 5th 2010 low:
Without going into too much detail, we see the same picture, only this time Technology is not a laggard. Technically, technology is underperforming the S&P 500 (red bar) by less than 1%, but that is not enough for cause of concern.
The Defensive Sectors are the relative strength losers while the Offensive Sectors are the relative strength winners.
Remember, we do relative strength work in comparison to the benchmark S&P 500, which is up 10% off the February 5th lows and is up 5% year to date.
Compare the other sector absolute returns to these benchmarks for the 'relative' performance and compare the sectors together.
Unless we start to see a rotation AWAY from the aggressive or offensive sectors and TOWARDS the defensive or conservative sectors, we should expect higher stock market prices to come in the future (not without pullbacks of course)
This would also suggest that the best swing trading positions will come from leading stocks in the leading sectors as shown above, and as new leaders potentially emerge.
Corey Rosenbloom, CMT
