Current Sector Rotation Insights

Aug 5, 2007: 6:04 PM CST

The action of the last week casts a bearish pall not only on the charts of the major indexes, but from the readings of the sector rotation model.

Let’s look at two graphs on sector rotation:

The first graph measures price movement/money flow of the last 65 days (a “longer” term perspective):


The brief interpretation is that money flow patterns remain to indicate “late business expansion” and the upper phase of the market cycle, nearing the “market top” phase.  According to this interpretation, there may yet be some more ‘steam’ left in the market, yet the negative action in the Financials Sector is troublesome.  The chart above seems to indicate a normal sector flow model.

Now, let’s look at the action over the last two weeks which paints an extremely different picture:


The action of the last two weeks is markedly bearish, in the sense that money is flowing decidedly into “defensive posture” sectors such as consumer staples and healthcare.  When this happens, it is a sign that big money players are fleeing to safety and moving money out of more risky areas/sectors and into areas that tend to perform well in ‘bearish’ market conditions or outright market declines.  If this pattern continues to hold up, this would be extremely negative for the broad market.

Remember that the consumer staples sector refers to companies that behave steadily through most all market conditions due to the fact that consumer buying patterns are stable with these products/companies.  Examples include cosmetics, toothpaste, household goods/cleaning supplies, etc.  We still have to brush our teeth and wash our clothes no matter how bad the economy gets.  When big money makes big bets in these sectors, it means they likely see trouble ahead in the market.

Also, I have included the weekly charts of the Dow Jones and the S&P 500.

While the S&P looks more troublesome than the Dow, at the moment, we are officially classifying the most recent decline as “yet another pullback” (pullback #3) until proven otherwise.


The Dow is perched just beneath its 20 period moving average, which occurred through the last two pullbacks.  Price may continue to decline past this zone, but buyers may step up and try to find value and begin buying in force… time will tell.

The S&P has a similar pattern, yet the pullback was steeper:


The pullback took us to the rising 50 period moving average, and the third test of a now-established trendline.

The broadbased S&P 500 also made a significant new momentum low, which also casts a bearish shadow over price action. From the standpoint of “Momentum Precedes Price”, we would expect a possible failed retest of highs that would result in new price lows.  What gives the benefit of the doubt to the bulls is the fact that no major index has made a new price low on the weekly charts.  Until this happens, the pullback is simply that – a pullback.

Recall that trends undulate in wave-like patterns with a series of higher highs and higher lows.  Until proven otherwise, the seemingly dramatic price declines have only made a higher low pattern.

Time will tell and there is only one truth:  Price.

Be safe and trade cautiously if neccessary.

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