Sector Performance Insights from the July Lows

Sep 10, 2009: 10:38 AM CST

Let’s try to glean some insights from the “Sector Rotation” model as we look at both absolute and relative (to the S&P 500) AMEX Sector SPDR  returns of the 9 major sector ETFs – paying special attention to the “Offensive” and “Defensive” Groups.

First, let’s take a look at Absolute Performance (percentage-wise) off the July 8th “Broken Head and Shoulders” Low (during the 17.5% rally in the S&P 500):

The S&P 500 (light red) is shown on the left, and I’ve drawn a horizontal line to reflect its performance.  Sectors that rose more than 17% “outperformed” the S&P 500 while those under the line “underperformed” the benchmark index (see chart below for a clearer picture of this… which shows the percent price beat or lagged the S&P 500).

I started the comparison off the “Busted” Head and Shoulders pattern off the July lows and we are trying to see whether or not the sector rotation model confirms the upward price move – it does.

During a “bull” or upward move in the market, we would expect “Offensive” (or “Aggressive”) sectors like Technology, Retail/Discretionary, Financial to be the strongest sectors… while we would also expect the “Defensive” or “Protection/Conservation” sectors such as Consumer Staples, Health Care, and Utilities to be the weakest.

This is in part because money managers want to be in the leading sectors during market upswings to capture more profit and then – due to some rules requiring them to be fully invested – want to preserve capital by investing in the ‘stable,’ usually higher dividend paying sectors (such as Utilities/Staples).

Look closely to see this pattern played out in text-book fashion above, which clues us in to the underlying (expected) market strength from the recent strong rally.

Next, let’s zero-in on the “Relative” performance… which shows how much each sector over or under-performed the S&P 500’s 17.5% return:

We see the same picture, only we now see exactly which sectors performed the best/worst relatively – keep in mind that all sectors ‘made money’ during the rally… it’s just that some sectors made more money than the S&P 500 while others made less.

Quite obviously, the goal is to determine which sectors are expected to outperform so portfolio managers can generate “alpha” or returns beyond what passive investment (perhaps in the SPY or DIA) could give.

Such a structure and understanding of “Sector Rotation” concepts can help in hedging a portfolio… but that is a topic for other posts.

Until we start seeing weakness in the Offensive sectors… and pick-ups in the Defensive Sectors (you’d need to look at shorter-term charts of the Sector Rotation model), we would expect this bullish picture to continue… particularly if the S&P 500 breaks to a new 2009 high this or next week.  If not, then look for the “Defensive” sectors to outperform on any down-move in the market.

Corey Rosenbloom, CMT
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