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The Lead-Lag Report: How Big Will the Market Correction Be?

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Despite some significant deterioration in market internals, enough positives remain to suggest that even if a correction is under way, it is likely a shallow one.

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Chaos is a name for any order that produces confusion in our minds.
-- George Santayana

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 that 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: DAZED AND CONFUSED

Financials (XLF) – Fighting the Good Fight



Comments: I have continued to stress the importance of financials in recent Lead-Lag Reports for the bulls given that any kind of sustained outperformance would be seen as a sign that financial conditions are easing and that reflation is expected globally, thanks to central banks around the world trying to avert another crisis. While the ratio has moved sideways in recent days, it remains a positive sign for overall markets that weakness has not returned after powerful leadership beginning in late November 2011.

Consumer Discretionary (XLY) – New Ratio Highs Despite Oil



Comments: I continue to be amazed at the resilience in consumer discretionary stocks, which in prior Lead-Lag Reports I have stated were likely to begin a period of relative weakness purely because of how long the sector has outperformed. Continues strength remains a positive sign for risk assets more generally even in the face of rising oil prices.

Consumer Staples (XLP) – Signs of Defensiveness Return



Comments: A healthy bullish environment is one where defensive sectors such as consumer staples continue to underperform broader equity averages. After a period of keeping pace with the S&P 500 in February, it appears that near-term strength could be returning in the sector as investors question whether a correction is upon us. A period of strength could kick in, but more time is needed to confirm if renewed leadership has returned in a sustainable way.

LAGGARDS: EMERGING MARKETS SET TONE

Industrials (XLI) – Sharp Weakness



Comments: Industrials substantially weakened on concern over a slower growth rate in China and as investors began taking some gains given how strongly the group has outperformed since late September 2011. Weakness may still be early on in the near term and could persist until investors have fully priced in the implications of tempered growth in emerging economies.

Bonds (IEF) – Re-Allocation to Stocks Continues



Comments: The most bullish argument for now is the continued outperformance of stocks relative to bonds, which looks to be continuing despite some troubling weakness in small-caps and underperformance in TIPS. This continues to show some confusion and uncertainty as to which way markets want to go.

TIPS (TIP) – Sharp Deterioration



Comments: The TIP/IEF price ratio is one way of seeing if inflation expectations are rising or falling within the bond market. When the ratio is trending higher, it means bets are occurring on rising prices ahead. When falling, deflation is the concern as nominal bonds become favored. The ratio substantially weakened in a dramatic way in recent days. The move may be an underreaction but may indeed be warning of a deflation pulse returning in the very near term.

Conclusion

There have been some major changes from last week's Lead-Lag Report, as market internals for the first time this year did deteriorate in a noticeable way. However, the message is inconsistent, which potentially means that if the correction is indeed here, it may be shallow and short-lived.

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
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.

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