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Michael Gayed: 5 Signs of Risk-On Behavior Amid Last Week's Decline


Charts indicate a favorable environment in US equities.

The S&P 500 (INDEXSP:.INX) declined -0.54% last week and the first two trading days of 2014 finished lower for the first time since 2005. However, amid this weakness, we saw a number of indicators pointing to the continuation of the risk-on trade:

1. Cyclicals continued to outperform the S&P 500, hitting new multi-year relative strength highs. When this ratio is rising, it is typically bullish for the economy and favorable for US equities.

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2. Financials closed higher on the week (top panel of chart below) with their relative strength against the S&P 500 moving sharply higher (bottom panel of chart below). The outperformance of financials is generally favorable for equities.

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3. US credit remained strong, with the High Yield Index (NYSEARCA:HYG) hitting new highs. When credit is stable or improving, it is generally a favorable backdrop for equities.

4. Consumer discretionary stocks continue to outperform the more defensive consumer staples, which is typically a positive signal for broad equities.

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5. High-beta stocks outperformed low volatility stocks, a classic sign of risk-on behavior.

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Overall, these indicators suggest that the backdrop continues to favor equities here despite last week's decline. My firm's ATAC models used for managing our mutual fund and separate accounts are currently in US small caps, reflecting a positive outlook for equities at the present time. My firm will continue to view elevated sentiment as the biggest headwind for equities in early 2014, but this could be resolved upon a consolidation or minor pullback.

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No positions in stocks mentioned.

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