The Lead-Lag Report: Correction Case Returns (Thanks, Cyprus)
Reaction by intermarket trends to Cyprus suggests that the odds of a correction are once again rising. Not all is right in the land of the Nouveaux Bulls.
-- Mark Twain
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.
Financials (NYSEARCA:XLF) – Unclear
Comments: Financials have been under some marginal relative pressure lately as Cyprus news roils European markets and puts a bid back into bonds. It remains to be seen if a reversal is about to take place, but the direction of relative behavior is a key tell on inflation expectations going forward.
Consumer Staples (NYSEARCA:XLP) – V
Comments: Consumer staples have staged a complete relative V formation, breaking down as jobs data surprised a few weeks back, and surging following Cyprus headline risk. The trend higher now appears to be back in place, signaling risk-off pressure for markets.
Long Bonds (NYSEARCA:TENZ) – Yield Curve...Flattening...Again?
Comments: The yield curve looked to be on the verge of steepening before widening following Cyprus. It is unclear if a trend is about to start, but this remains an important relationship to watch for a potential risk-off period ahead.
LAGGARDS: CYCLICAL BREAKDOWN
Energy (NYSEARCA:XLE) – Downward
Comments: The cyclical trade continues to underperform, with energy lagging alongside other globally sensitive growth plays. I suspect a stopping point will occur around the 0.50 level, but for now the trend remains down. Leadership, however, may ultimately coincide with emerging market outperformance to come.
Industrials (NYSEARCA:XLI) – Collapse
Comments: Industrials have had a huge move in relative terms since mid-October, coinciding with strength in emerging markets and a return of risk-taking. A second attempt to break the moving average failed, with a sharp breakdown, followed by another move higher. A complete collapse has now taken place, and may be an ominous sign about global growth expectations.
Emerging Markets (NYSEARCA:EEM) – Severe Breakdown
Comments: The severe breakdown in emerging markets has been nothing short of stunning, and may be nearing capitulation relative to the S&P 500 (INDEXSP:.INX). There will be a time when emerging markets are a fat pitch for equity bulls, but the ratio needs to recover persistently first before a trade can be comfortably made.
The case for a correction appears to be back on the table following the reaction of various intermarket trends to Cyprus. More time is needed, but the risks of a declining equity environment are increasing in probability, as the deflation pulse beats from overseas. The $85 billion/month question is if the honey badger US stock market will care. My firm's ATAC (Accelerated Time and Capital) models used for managing our mutual fund and separate accounts remain defensively positioned.
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.
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