The Lead-Lag Report: Cyclical Melt-Up Coming?
Market internals continue to improve, and may be nearing a self-sustaining point. The next rotation is likely away from the bear/low beta trade and into the global growth/cyclical one.
Again, be careful to make a good improvement of previous time.
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.
To read the full Lead Lag report, click here.
LEADERS: BEAR TRADE DROPS OFF
Energy (XLE) – Tensions Rise Along With Oil
Comments: Energy continues its surge, strongly outperforming the Dow in the last several weeks. Much of this may be attributable to growing concerns over Iran and a potential coming oil spike. Given how badly energy has underperformed, it would make sense to expect some further leadership ahead.
Industrials (XLI) – Welcome Back
Comments: Industrials seem to be on the verge of renewed leadership here, which would signal strong potential leadership in emerging markets and cyclically sensitive areas ahead. More time is needed to confirm, but the odds seem likely to favor a return here.
Treasury Inflation Protected Securities (TIP) – Reflation Returns?
Comments: The TIP/IEF price ratio is one way of seeing whether 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. Notice how sharply the ratio collapsed and hit support levels not seen since post October 3 low. A recovery may be in order, which would be a bullish sign for markets overall.
LAGGARDS: RETEST AND ROTATION
Materials (XLB) – Retest
Comments: Materials began breaking down on a relative basis in recent days and is now nearing its support level last hit before the June 4 absolute low in equities. The sector may be in the midst of a retest, but I suspect the support level will hold given the potential for monetary policy action by both the Fed and the European Central Bank.
Consumer Staples (XLP) – Turned Back at Resistance
Comments: Consumer staples remains likely to weaken, which from a risk-sentiment standpoint, is bullish for equities. When money moves away from low cyclical sectors, it means the environment is more conducive to stocks. The next week will provide deeper clarity.
Small-Caps (IWM) – Support in Sight
Comments: Small-caps have given back the outperformance spike that occurred at the very end of June, as market internals began deteriorating since July 5. Still, the ratio is nearing support, which if held is likely a bullish sign.
Market internals continue to look healthy and are pointing toward a meaningful reversal in the bear trade. The next few weeks will be crucial as likely any kind of monetary action could serve as the tipping point of forced reflation. A return in leadership to the cyclical trade is now crucial to watch.
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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