The Lead-Lag Report: October Correction Warning

By Michael A. Gayed  OCT 02, 2012 1:40 PM

Market internals have markedly deteriorated, as the odds increase for an October correction. Beware the message of the bear trade.



To cease to admire is a proof of deterioration.
-- Charles Horton Cooley
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.
For a full version of the Lead-Lag Report, click here.
Health Care (NYSEARCA:XLV) – Surging

Comments: While it appeared a continuation of underperformance was likely two weeks ago, a V-formation seems to be underway.  This remains a concern in the very near-term given risk sentiment, which appears to be deteriorating.
Utilities (NYSEARCA:XLU) – New Strength?

Comments: Utilities are catching a bid relative to broader market averages, but it remains to be seen if strength will persist as it did during the May mini-correction.  Having said that, continued outperformance in defensive areas of the market remains a warning sign for broader risk sentiment in the here and now.
Consumer Staples (NYSEARCA:XLP) –  Defensiveness Increases

Comments:  Consumer staples continue their strength in sympathy with Treasuries, health care, and utilities, as money takes itself off the table following the Fed's QE3 announcement. The surge is troubling, and may be warning of a potential correction in equities for October.
Consumer Discretionary (NYSEARCA:XLY) – Down Again

Comments: Last week I stated, “Discretionary stocks remain in the leadership category, but I maintain that the group is tired. A recovering housing markets and pledge by the Fed to do whatever it takes to bring joblessness down has bolstered the group, but performance is extended.” It appears that weakness is now setting in. The sector remains one to be bet against on the short side, and avoid on the long side independent of any kind of wealth effect the Fed's QE3 program creates.
Small-Caps (NYSEARCA:SLY) – Broken

Comments: Small-caps appear to have broken their trend in the very near-term as money positioned defensively into the end of the third quarter. It appears money is beginning to favor more overseas investments rather than domestic beta in the here and now.
Technology (NYSEARCA:XLK) – Broken

Comments: Despite continued hype and excitement over Apple (NASDAQ:AAPL), the technology sector appears to be in the early stages of weakness as it rolls over relative to the S&P 500. The sector's strength appears very much broken in the near-term

Market internals have been deteriorating meaningfully in recent days. The odds of a correction appear to be increasing, but it is not clear just yet how severe a decline could be. Caution in the very near term likely remains warranted.

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