The Lead-Lag Report: Correction Odds Remain Elevated
The odds favor further weakness in broader averages, but impressive financials continue. Does the correction end with a thud?
You need to overcome the tug of people against you as you reach for high goals.
-- George S. Patton
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: CHANGES COMING BUT NOT JUST YET
Materials (XLB) – Waiting on Confirmation
Comments: Materials crossed from laggard to leader last week after spiking off of ratio lows earlier this month. Stronger earnings from companies in the sector are countering concern over a slowdown in China. More time is needed, but the ratio remains likely in the early stages of an uptrend.
Consumer Discretionary (XLY) – A Reversal in the Making?
Comments: While the sector has pulled back off of ratio highs hit last week, the trend still looks to be up, though admittedly the sector could be in the early stages of a near-term reversal. More time is needed to see if stubbornly high oil prices are finally having an impact on sentiment toward consumer spending.
Health Care (XLV) – Strengthening Defensiveness
Comments: Continued strength in health care suggests bearishness is creeping into risk assets despite a relatively resilient S&P 500. The ratio may continue to trend higher to around 0.276 which is roughly where resistance occurred in the past and further leadership stopped.
LAGGARDS: BETA HOLDING ON
Financials (XLF) – Stable, but Trend Unclear
Comments: I have noted numerous times the importance of financials to the broader bull market and reflation theme. Financials dramatically underperformed last year, and staged a period of strength since December. The ratio has recently fallen below its 20-day moving average, in the first significant sign of negative sentiment creeping into risk assets so far this year. There did appear to be some stabilization last week. More time is needed to confirm which way financials will go next relative to the broader stock market.
Technology (XLK) – Trend (Badly) Broken
Comments: I noted last week that "it appears that leadership in technology is now under attack given underperformance by Apple (AAPL) and momentum traders getting afraid of a deflation pulse beating in this mini-correction we appear to be in. The trend has been quite powerful since the beginning of the year, and it would not surprise me to see bigger weakness to come in the next several weeks." Apple has been a major driver in recent broader tech weakness. Earnings and the reaction to that will be key to see which way the trend likely goes from here.
Small-Caps (IWM) – Flatlining
Comments: Small-caps have strongly underperformed large-caps since about February, and may be nearing the end of its downtrend as the ratio bounces off of support. More time is needed for leadership to emerge, but I suspect outperformance can begin some time next month.
The tug-of-war continues as the bulls and bears duke it out through the bear trade, which continues to outperform and coincides with financials, which refuse to collapse further relative to broader stock market averages It does seem possible that the corrective environment resolves itself through time rather than through a big drop.
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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