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The Lead-Lag Report: An Emerging Great Rotation

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A different kind of Great Rotation is underway as US stocks begin to crack and overseas emerging cyclical plays begin to rally.

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I'm looking for the unexpected. I'm looking for things I've never seen before.
--Robert Mapplethorpe

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.

LEADERS: DIFFERENT KIND OF GREAT ROTATION

Consumer Discretionary (NYSEARCA:XLY) – Failure?



Comments: The discretionary sector has been a star outperformer in 2013, but appears now to be breaking as higher oil and gas prices sap money from the consumer. It is interesting to note that this is occurring alongside weakness in homebuilders, indicative of some concern over the future outlook of spending power and the wealth effect. This is an important sector to watch for domestic expectations going forward.

Industrials (NYSEARCA:XLI) – Global Trade



Comments: Industrials have held a rough uptrend since mid-May, with quite a bit of volatility as of late on lingering concerns over China's growth rate. Recent strength seems to be driven by renewed interest in the global growth/reflation trade, with China leading the charge and commodities bouncing back.

Materials (NYSEARCA:XLB) – Boom



Comments: Materials, like energy, have had a hard time outperforming this year, but recent behavior has been very powerful. A breakout move may be here, coinciding with strength in overseas commodity plays and anything sensitive to an increased pace of growth for China.

LAGGARDS: CRACKS

Financials (NYSEARCA:XLF) – Not Good



Comments: Financials tend to outperform when the yield curve steepens as bets increase on lending and economic activity. After a strong period of outperformance, weakness has kicked in despite the yield curve still steepening. This kind of divergence may be a warning sign of coming US weakness.

Consumer Staples (NYSEARCA:XLP) – Stabilizing



Comments: The peak in consumer staples occurred just before the taper spasm broke down the yield play. Some stabilization does appear to be taking place on bets that the Fed may not aggressively pull back stimulus any time soon. A continuation of the bull market likely coincides with a further drop from these ratio levels, and leadership in more beaten down sectors of the market.

Long Bonds (NYSEARCA:TENZ) – Yield Curve Support?



Comments: The yield curve has steepened as the market reprices potential QE tapering, and has bounced off of a support level as of late. Some leadership in longer duration bonds does seem plausible, especially given weakness expressing itself in financials, homebuilders, and consumer discretionary stocks, independent of tapering.

Conclusion

Emerging cyclical trades are showing signs of meaningful strength as cracks emerge in US equities. An unexpected correction of falling US stocks coupled with rising international equities may be in the cards, just in time for "Sep-taper."

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.

Twitter: @pensionpartners
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No positions in stocks mentioned.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

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