Cruel leaders are replaced only to have new leaders turn cruel.
-- Che Guevara
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: THE RIGHT LEADERS FOR BULLISHNESS
Consumer Discretionary (XLY) – Wowzers
: Discretionary stocks continue unabated, as hopes for additional quantitative easing from the Fed increase, and as housing itself recovers. I maintain that discretionary stocks are a tired leader given the extent of time the group has outperformed.
Financials (XLF) – Still Early
: Financials continue to fight back, which makes sense on a return to reflation. Potential QE3 coming from the Fed means banks recover as yield curves steepen and inflation expectations return. This remains a very important sector to pay attention to in the coming days. The move is early, and very bullish from a sentiment standpoint.
Small-Caps (IWM) – Mirroring Fall Melt-Up of 2011
: Small-caps are now showing behavior similar to what happened during the Fall Melt-Up of last year. A repeat may very well occur given weakness in the bear trade and a recovery in risk-taking underneath the market's surface, particularly on Fed action to come.
LAGGARDS: TECHNOLOGY MOST VULNERABLE
Technology (XLK) – Leadership Broken
: Last week I noted that “the sector ETF is now nearing an important relative resistance level, which could serve as a stopping point for continued leadership given how well the group has performed thus far in 2012.” It appears that a meaningful break is underway, as money rotates into other sectors.
Utilities (XLU) – Unrelenting Continuation
: Utilities continue to break down, and appear to still have further to fall. This remains a positive sign for markets given the role utilities has as a “place to hide” in equities when volatility is rising and recession fears increase. The underperformance has been unrelenting.
Emerging Markets (VWO) – China Catalyst?
: It appears third time may be the charm for emerging markets as a third bottom may now be in place. The group has has a hard time leading, but a spurt of strength driven by China stimulus hopes may be just the catalyst needed for sustained leadership. I maintain that the next major rotation likely in the fourth quarter is in emerging economies.
Intermarket trends remain favorable for equities, and the cyclical trade remains the most important to watch. The next rotation likely is in emerging markets, financials, and anything most sensitive to rising inflation expectations, which appear to be forced upon us by SuperBen and the League of Extraordinary Bankers.
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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