October Signals from the Sector Rotation Model

Oct 6, 2011: 3:01 PM CST

What is the broader Sector Rotation Model saying about the current state of the stock market?

Let’s take a look from two perspectives:  January to October (year to date) and then from the May 2011 peak to present.

First, the longer-term year-to-date Sector (ETF) performance:

Before we look at the current picture, feel free to take a moment to view my prior update on the Sector Rotation Model from July 2011 which forecast market weakness ahead of the August plunge.

Actually, my May 2011 update “Clear Bearish Signals from the Sector Rotation Model” showed a similar “bearish ahead” picture that materialized in the months that followed.

So has anything changed from the May and July ‘bearish’ Sector Rotation Model updates?

In short – not really, but there is one change to note with regard to Technology and Consumer Discretionary sectors.

The Model shows year-to-date weakness (underperformance) in the Financial ETF – XLF (down 25%), Materials (XLB down 17%) and Industrials (XLI down 13%) when compared to the year-to-date loss so far of 9% for the S&P 500.

There’s actually a speck of bullishness – or at least hope – to note in terms of the relative outperformance of Consumer Discretionary/Retail (down 4%) and Technology (XLK – down 3.5%).

Energy (XLE) roughly ties the performance of the S&P 500 so far year to date.

The only sectors to be positive on the year are the Defensive Sectors, such as the Utilities (up 7.5%), Consumer Staples (up 3%), and Health Care (up 1%).

This is precisely the performance action you would expect to see in a down/defensive market – relative strength appears in the Defensive names while weakness appears in the Offensive names.

Let’s see if we can get any extra information from a closer view of recent market action from May 2011 (the peak) to present (early October):

Let’s start with the good news – the ONLY sector (ETF) to be positive since the early May 2011 stock market peak is the Utilities (XLU) which generally pay higher dividends and outperform in a bear/declining stock market.

That’s not all the good news however – again, we see slightly stronger relative performance in Consumer Discretionary/Retail (down 12%) and Technology (down 9.5%) when compared with the near-official “Bear Market” sell-off in the S&P 500 – down 16% (after touching an intraday low of a 20% decline on October 4th).

Unfortunately, the rest is bad news.

Financials have yet again been hit the hardest, declining over 26% in the last four months, closely followed by other “Offensive Sector” members Materials (down 24%) and Industrials (down 22%) accordingly.

The wild card is the Energy Sector (it’s generally neither classified as offensive or defensive) which puts in the second worst relative performance – down 24.23%.

Anyway, the Sector Rotation Model is helpful in that it clues us in to the movements of “Big Money” in a sense, with regard to where they seem to be over or under-weighting their portfolios on a relative basis.

For stock-pickers, it also gives a helpful opportunity to find the strongest stocks in the strongest sectors along with the weakest stocks in the weakest sectors to “ride the sector tide” of the broader market movements.

Continue watching these sectors in conjunction with the S&P 500.

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

Corey’s new book The Complete Trading Course (Wiley Finance) is now available!

2 Comments

2 Responses to “October Signals from the Sector Rotation Model”

  1. Friday 7atSeven: coming home | Abnormal Returns Says:

    […] What the sector rotation model saying about the market.  (Afraid to Trade) […]

  2. Rich Says:

    I re-read the two articles mentioned above; I had read them previously when they were first published.  All I can say is that I wish that I heeded the information/warnings contained in them better than I did.   My early risk management during the approaching downturn was fairly dismal and I ended up paying a hefty price.  

    What did happen, is that I waited for better confirmation drawing and watching the SPX trend line from March 09 (as illustrated by Corey in another post), decided that I would lighten up on holdings if the trend line was crossed, after it crossed waited to make sure it was going to stay crossed, then when the market plunge started and picked up momentum froze like that deer in the headlights being truly “Afraid to Trade”.    Need to get better at this stuff, definitely.