The Lead-Lag Report: Sharp Cyclical Rotation
A large break in defensiveness has occurred on the heels of Friday's jobs report, putting a bid into oversold cyclicals. Now Nouveaux Bulls and Gray Haired Bears must decide if it will last.
--Michael E.S. Gayed, my father, in the second edition re-release of Intermarket Analysis and Investing
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: CYCLICALS RALLY FROM OVERSOLD
Energy (XLE) – Sharp Move
Comments: Last week I noted that "like small-caps, energy nicely rallied in recent days, but appears to be getting turned away after hitting its 20-day moving average. More time is needed to confirm, but the trend in weakness could very easily reassert itself should the deflation pulse continue to beat." A break in the downtrend appears to be happening, consistent with a rotation to cyclicals.
Industrials (XLI) – W
Comments: A complete reversal and W formation has taken place in industrials, breaking the downtrend as the market suddenly reprices out the deflation pulse. This is consistent with various other intermarket trends in terms of the rotation into cyclicals which appears to very much be underway.
Materials (XLB) – V Holds
Comments: Materials have V'ed in a way consistent with the idea that the cyclical trade was oversold. Given the extent of weakness, the ratio could rally back to the year's highs, coinciding with emerging market strength and continued yield curve steepening which may lie ahead.
LAGGARDS: DEFENSIVES BREAK FROM OVERBOUGHT
Consumer Staples (XLP) – Is Mean Reversion Over?
Comments: Consumer staples leadership has been nothing short of stunning, as the ratio hit pre-fall melt-up of 2011 levels. The mean reversion I argued was likely in prior Lead-Lag Reports seems to be unclear, with a complete breakdown reminiscent of the fall melt-up of 2011. This indicates that a sharp re-pricing of the deflation trade is occurring.
Health Care (XLV) – Pop?
Comments: Health care had gone vertical in terms of dramatic outperformance this year, reminiscent of early 2011 prior to the summer crash. The trend appears to have broken over the past few days with a sharp sell-off underway relative to the S&P 500 (INDEXSP:.INX). This might indicate that a bursting of the "ratio bubble" I alluded to in prior Lead-Lag Reports may be underway.
Utilities (XLU) – Severe Break in Trend
Comments: Much like consumer staples and health care, significant outperformance in utilities has been a part of the defensive posture within markets up until last week, when a very severe break in trend took place. This furthers the argument that an aggressive repricing of the deflation trade is underway.
A significant repricing appears to be underway with money favoring cyclical trades which have lagged throughout the deflation pulse, and defensives which have illogically driven markets higher. It remains to be seen if this is a simple trade as opposed to a longer theme. My firm's ATAC (Accelerated Time and Capital) models used for managing our mutual fund and separate accounts rotated into stocks last Friday to play oversold cyclicals, but remain ready to position out should disconnects not fully be resolved.
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.
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.
Daily Recap Newsletter