The Lead-Lag Report: Cyclical Capitulation?
A critical moment appears to be at hand as materials, industrials, and emerging markets act in a capitulation-like way relative to the S&P 500. A powerful bounce may soon occur, similar to what has happened to small-cap stocks in the past 30 days.
Who can be patient in extremes?
-- William Shakespeare
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: FINANCIALS HIGHLY ATTRACTIVE
Technology (XLK) – Hitting Resistance
Comments: Technology has outperformed the S&P 500 as Apple (AAPL) momentum continues unabated. The sector ETF is now nearing an important relative resistance level, which could serve as a stopping point for continued leadership given how well the group has performed thus far in 2012.
Financials (XLF) – Early and Bullish
Comments: Financials are trying to fight back, which makes sense on a return to reflation. Potential QE coming for Europe and the US means banks recover as yield curves steepen and inflation expectations return. This remains a very important sector to pay attention to in the coming days. The move is early, and very bullish from a sentiment standpoint.
Small-Caps (IWM) – Just Like Fall Melt-Up of 2011
Comments: Small-caps are now showing behavior similar to what happened during the Fall Melt-Up of last year. A repeat may very well occur given weakness in the bear-trade and a recovery in risk-taking underneath the market's surface, particularly on central bank action, which seems likely to come any day now.
LAGGARDS: INDUSTRIAL CAPITULATION?
Energy (XLE) – End of Isaac, End of Leadership?
Comments: With Hurricane Isaac come and gone, refineries have been put back to work, as the sector itself begins underperforming the broader stock market. I am not convinced of a meaningful period of weakness, though, as more time is needed to see if this is just a reaction to post-Isaac production or something else.
Industrials (XLI) – Resistance Again
Comments: Industrials sharply underperformed as China itself hit 2009 lows once again on an absolute price basis. The ratio is now hitting against resistance after underperforming in a very sharp way. This could be an extreme move that warrants a counter-trend period of strength, particularly as the ECB and Fed act on more stimulus.
Emerging Markets (VWO) – Critical Juncture
Comments: Emerging markets have collapsed in recent days, and are now around a crucial ratio low and support. Coming European Central Bank action may be all that is needed to get export-dependent emerging economies to rally meaningfully, in what could be a chase into risk assets and out of the dollar.
Conclusion? Intermarket trends remain favorable for equities, and a capitulation move may be occurring in the industrials, emerging markets, and materials trade. The next two weeks will likely set the tone for the rest of the year in markets, as central bank actions are taken, and money takes a stand on how much risk it wants to take.
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