Sector Rotation View

Aug 26, 2007: 5:33 PM CST

Let’s look at what the Sector Flow Model is showing us, both on a short-time frame and longer out.

First, let’s look at the Inter-market Chart from StockCharts.com:

This chart may be a bit complex to understand, but let me just focus on one point:

View only two lines:

  • The Purple Line (bottom) which is the 30 Year Bond Price

     

  • The Red Line (top) which is the S&P 500 Index

     

Historical Fact: Bond prices tend to LEAD the S&P by three to six months, but often trend in the same direction as the S&P 500 unless something is out of line

Observation: Bond prices began to decline and trend lower from March, 2007 until they ‘bottomed’ in June 2007, and five months after bond price began to decline, the S&P experienced its sharp decline in late July 2007. One could have had a potential “heads up” about the potential action by the leading action of the bond market.

Observation: Bond prices appear to have ‘bottomed’ in June, 2007 and have been leading upwards, indicating that higher prices may be in store for the general stock market 4 to 6 months away from that period, which would be occurring now.

Question: Are bond prices forecasting an end to the recent market decline? Time will tell, but it is a ‘bullish’ sign.

 

Now let’s look at Sector Flow:

The above Three Month “Flow” chart indicates normalized money flow that signifies a comfortable bull market in its last stages. The final ‘stage’ of a bull market is when the Energy sector outperforms for an extended period of time. The large black bar represents the Energy sector. It is a positive sign that the technology sector is doing well.

Let’s zoom the money flow in to the last month:

The picture painted by the last month shows an early bear market, as evidenced by the posturing of the “Big Funds” as they place their funds into more “defensive” sectors such as Consumer Staples and Utilities. These sectors are often non-volatile and are good refuges for funds that must be invested “long” the market at all times.

As the theory goes, everyone must buy toothpaste, cleaning supplies, and use power (utilities). Therefore, when the “Big Money” rotates heavily into these sectors, that is a generally bad sign (bearish) for the overall market.

Summary: We’re not seeing overly bullish signs from the Sector Rotation Model; in fact, signs point to increasing bearishness and defensiveness.

The overall markets are now in confirmed technical downtrends (lower lows and lower highs) on the daily chart, but the indices are still in confirmed uptrends on their weekly charts.

In this environment, caution is warranted… but did you need me to tell you that?

 

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