The Lead-Lag Report: Conditions Get Challenging
Market internals have weakened in the past couple of weeks, but the path is still higher as favorable conditions remain internally within markets.
Although our intellect always longs for clarity and certainty, our nature often finds uncertainty fascinating.
-- Karl Von Clausewitz
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 larger version of the Lead-Lag Report, click here.
LEADERS: DEFENSIVENESS CATCHES A BID
Consumer Staples (XLP) – Surprising Strength
Comments: Two weeks ago I noted that "consumer staples rallied post Operation Twist like utilities, but the ratio still looks likely to trend lower. A series of lower relative highs suggests more downtrend to come." The comeback in the staples sector has been significant, and sends the ratio back to resistance levels. A breakout above this would be a negative sign for markets overall.
Health Care (XLV) – Volatile Leadership
Comments: Health care has been a volatile leader, particularly post-Supreme Court decision. The ratio is slightly above resistance, and may have further to run. However, the extent of outperformance makes this a tricky trade for the longs.
Energy (XLE) – V?
Comments: Energy appears to be in the early stages of a V-like formation as oil itself rebounds. It is worth noting that this is happening despite global growth slowdown concerns. Given the extent of underperformance, a recovery is likely in order.
LAGGARDS: CYCLICAL CAPITULATION?
Technology (XLK) – Bearish Sentiment Reasserts Itself
Comments: Weakness in technology appears to be in its early stages which I have noted in prior Lead-Lag Reports was a likely scenario. Dour sentiment on semiconductor stocks and disappointing guidance means the sector could continue to drag lower in terms of underperformance.
Consumer Discretionary (XLY) – Downtrend Intact
Comments: Discretionary stocks weakened significantly since late May. Low oil prices are not stoking demand in the group, which has been a strong performer since 2008. Betting against discretionary is likely a high-probability trade in terms of lagging other areas of the market.
Industrials (XLI) – Hard Breakdown
Comments: Industrials cratered in the last couple of weeks as concerns have grown over China's slowdown and the recent weak PMI data that has come from multiple countries. The ratio remains near support, and the next few weeks will be important to watch.
Market internals appear considerably more tempered than they were in early June, suggesting a rocky road may be ahead of us until price is able to decide which way to move. There are enough positive signs though to suggest that the path most likely remains higher.
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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