We gain strength, and courage, and confidence by each experience in which we really stop to look fear in the face...we must do that which we think we cannot.
Below is an assessment of the performance of some of the most important sectors and asset classes relative to each other, with an interpretation of what underlying market dynamics may be signaling about the future direction of risk-taking by investors. The below charts are all price ratios which show the underlying trend of the numerator relative to the denominator. A rising price ratio means the numerator is outperforming (up more/down less) the denominator.
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LEADERS: IT'S GETTING FUN AGAIN
Materials (XLB) – Bullishness Increases
: While materials meandered a bit in the past few days, the trend of leadership still appears to be in place. Should this continue, it would be a bullish sign as it would further the case I have been making that reflation expectations are returning to markets.
Emerging Markets (VWO) – Strength Builds
: Emerging markets continue to creep higher relative to the US given the realization that growth is still strong overseas and that monetary easing could spur reflation in many exporting economies. The ratio appears to be only just getting started, with potentially much room to rally further given asset manager under-weighting in the past two months.
Long Bonds (TLH) – Barely Holding On
: The peak in the ratio may have been precisely where the “Spring Switch” I have been addressing following the Summer Crash, Fall Melt-Up, and Winter Resolution, got flipped. The trend is struggling to hold on, but I suspect a meaningful reversal is likely as the yield curve steepens on the realization of reflation to come.
LAGGARDS: BEAR TRADE ENDS
Utilities (XLU) – Emerging Weakness?
: Utilities finally seems to be on the verge of weakness as market sentiment improves following Greek elections, despite continued fears over Spain and disinflationary pressures. Continued underperformance in utilities would be a signal of further risk-taking ahead, and that investors are shifting away from dividends and more toward growth.
Consumer Staples (XLP) – Turned Back at Resistance
: Last week I noted that “a failure to break out to new ratio highs would be seen as a bullish sign for equities. If a downtrend emerges, it suggests the fever has broken and a recovery in stocks is likely in order.” The ratio did decline below its moving average, suggesting further improvement in risk sentiment as money flees defensive sectors.
Health Care (XLV) – Three Strikes and...
: Health care has now failed three times to get past ratio support, and appears to be in the early stages of a more meaningful period of underperformance, in sympathy with utilities and consumer staples. Noise may come in to play as elections occur, but the trend favors other sectors to play the long side.
Market internals are vastly bullish, signaling a continuation of a melt-up in risk assets as "scared money" gets scared that it's wrong, and as the end of the "end of the world" trade takes place.
Editor's note: This update is published every week exclusively for Minyanville, and is compiled by Michael A. Gayed, CFA, Chief Investment Strategist of Pension Partners, LLC.
No positions in stocks mentioned.
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