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.
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.
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