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The Lead-Lag Report: Headed for a Crash or Another Melt-Up?

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At this critical moment, market internals are behaving as if a crash is likely if not underway. Should the fever break, a significant counter-rally could ensue.

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MINYANVILLE ORIGINAL

I love the urgency of what we do. I like the battles that take place, the jousting.
--Mike Wallace

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 see the full version of the Lead-Lag Report, click here.

LEADERS: BEHAVING LIKE A CRASH...BUT IS IT ONE?

Health Care (XLV) – Hanging around Resistance



Comments: Health care's outperformance has gone vertical as severe market deterioration persisted last week. Health care is now sitting at ratio resistance, and could quickly reverse leadership should markets stage a comeback in the very near-term from oversold levels. A break above resistance, however, would be an ominous sign of further bearish sentiment.

Utilities (XLU) – What Now?



Comments: Utilities went nearly vertical last week as stock declines accelerated and bonds performed strongly. Weakness set in yesterday, but the trend remains strong. A reversal in strength likely needs to confirm any kind of a real return of the bull market for broader equities.

Consumer Staples (XLP) – Fear Trade



Comments: Like utilities, consumer staples went vertical last week and is also hitting ratio resistance, being turned away in the most recent price action. If a downtrend emerges, it suggests the fever has broken and a recovery in stocks is likely in order.

Long Bonds (TLH) – Breaking Ratio Highs



Comments: Long bonds (TLH) relative to shorter duration Treasuries (IEF) have dramatically outperformed, reaching new all-time ratio highs as last week equities broke down. A rising ratio means investors are favoring duration when allocating to bonds, which is a sign of defensiveness. The next few weeks could result in a reversal, which would be conceivably bullish for risk assets, however it is concerning to see such fear being expressed in the bond market.

LAGGARDS: WELCOME THE CONSUMER

Consumer Discretionary (XLY) – A Reversal...Finally?



Comments: Discretionary stocks have weakened substantially since the month of May began and the sector is now trading below its 20 trading day (one month) moving average. Given how long discretionary stocks have outperformed, this could be a major turn in the behavior of consumer companies relative to the broader market.

Financials (XLF) – Blame JPM and Junk Debt



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 broke down significantly on JPMorgan's (JPM) $2 billion loss which received much attention. If leadership does not return, this could be an ominous sign of further weakness to come.

Conclusion

Markets appear to be at a critical juncture. Ratios are behaving as if a crash is (or will be) here, which means either one of two scenarios has to happen. Either further declines occur in a waterfall fashion should the "bear trade" be correct, or another "melt-up" scenario in broader equities returns. The next few weeks should provide market participants with a clearer answer.

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.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

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