Weekend Sector Rotation Overview

Dec 2, 2007: 4:30 PM CST

It’s time to expand our horizons beyond the stock market to other inter-related markets and also glean insights from the sector rotation model.

All charts are courtesy StockCharts.com, and we will be examining the “Intermarket Relationships” profile of the last 200 days first:

I have highlighted the clear negative correlation (inverse relationship) between commodities (blue line) which have been making new highs and have outperformed all other asset classes on the chart this year and the US Dollar Index (green line) which has – not surprisingly – underperformed all other above asset classes.

The next observation is the recent divergence between commodities and the US Stock market. Notice how the two have generally followed a positively correlated relationship until two months ago when commodities ($CRB Index – blue) have risen relative to the S&P 500 index (red).

Bonds have historically led stock prices in the short-term (sometimes by three to six months), and if that is to be the case again, we see bonds have been increasing in value since October (as a result of the Rate Cuts by the Federal Reserve and the ‘flight to quality’ in which investors have been buying bonds and exiting stock positions).

John Murphy at StockCharts.com summarizes the four major asset class relationships as the following:

What’s throwing the model off currently is the positive relationship between commodities and bonds which has been occurring since mid-August 2007.

Notice how the Dollar Index has continued to make new relative lows all year long.

Now, let’s look quickly at the Sector Rotation Model:

I have divided the chart into two segments:

“Expansion” refers to sectors that tend to do well (outperform) when the economy is expanding, business is growing, and the stock market is expected to rise.

“Defensive” refers to sectors that do well (outperform) when the economy is contracting, business is retracting/downsizing, and the stock market is expected to decline.

We see now one of the clearest pictures from the Sector Rotation Model possible: Over the last 65 days (from late August until late November), money (the large funds) have clearly favored defensive, safer positions than the more risky positions established when the economy and stock market is expected to rise.

What this means according to the model is that the “Big Funds” who must be ‘long’ the market (such as major mutual funds, etc) are preferring the safety of quality over risk-taking positions in the current environment.

Despite the large recent moves by high-flyers such as Research in Motion (RIMM), Apple (AAPL), Baidu.com (BIDU), and Google (GOOG), the technology sector remains barely profitable over the period on the chart.

Odds are favoring placing longer-term positions in safer areas that do well when the market is expected to decline… or in the safety of bonds.

Keep in mind that the month of December has been known to return positive returns on aggregate in the stock market, and be especially cognizant of the upcoming “Santa Claus Rally” which takes place before/after the Christmas holidays.

Be safe in this current murky market environment.


3 Responses to “Weekend Sector Rotation Overview”

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