Sector Rotation Chart Apr 15

I wanted to introduce a few sector rotation analysis charts.  Sector rotation – once understood – can provide clues as to the future of the broad market, as well as opportunities for both investment, trading, and hedging decisions.

I recommend learning more on Sector Rotation, but I will be providing brief possible implications based on the graphs (all graphs courtsey StockCharts.com).

Sector Strength Line Chart – 3 Months 

Energy, Materials, and Utilities all increased 10% from January 1st.  From a sector rotation model, this is a negative sign for the economy, as these sectors tend to outperform directly before or during a market top.  The theory states that the market cycle leads the economic cycle by three to six months, and if this is correct, we are achieving a possible peak in the business cycle.

Sector Rotation Bar Chart – 3 Months

This chart shows the same information, only in bar chart form.  The theory states that the sectors rise (in this chart) from left to right as institutional money flows from sector to sector, based on what the general economy is expected to do, and what the climate from interest rates (cycle) is experiencing (high or low).

Money tends to flow into “defensive sectors” like healthcare, consumer staples (things we HAVE to have regardless of the economy), and Utilities (as interest rates fall) during market/economic peaks.  This is a hidden way “Big Money” protects themselves from downturns in the market.  It appears we are seeing this progression now.  Also, high energy prices tend to mark the end of market peaks because demand is high for energy, but higher prices serve as a “tax” on average Americans and businesses, cutting their bottom line and curbing spending.

Anyway, a thorough explanation of Sector Rotation Theory is beyond this blog, but I do recommend reading more on the subject.

Here is a Chart detailing a “quick study” of Sector Rotation Theory and how the Stock Market (and sectors) lead the Economic Cycle (recovery, expansion, contraction).

I have added two arrows of possible location of the stock market cycle (sector rotation) based on the above data.  IF this is correct, it would imply a near peak for economic conditions.

One note of caution against reading too much into the model … similar patterns occurred last May (06) when the market fell 10%, and many people were calling for a recession.  However, unexpectedly, energy prices fell, tension in the Middle East (Israel) subsided, the Fed indicated it would no longer raise rates, and other economic conditions approved as the market crept higher (probably because of the doomsayers).

While 2007 might be different, I am reading into this analysis that caution ahead is warranted, BUT that underlying market prices and trends overrule any fundamental analysis.  After all is said and done, PRICE is king and there can be so much negative information out there, yet if the market continues to creep higher, all that matters is making money, and that is done by following the direction of the market IN SPITE of all the news.

Nevertheless, I don’t think this is the time to load the boat with long-term position trades, either.

Price rules and it is easier to take the market one swing or one play at a time, while viewing the underlying forces that drive price in the long term.