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Sector Rotation or New Bear Market?


...a basic understanding of what is trending in which direction is helpful to anyone.

A debate that is starting to gather some momentum is whether or not the current market slide is merely a change in leadership or the start of something much more. Both sides have merit, but not a single person can predict with accuracy how it will all play out and unfortunately, we will only know when it is over which side was correct.

Whether it is your style to review charts or not, it doesn't take a technical analysis guru to identify trends to see what is moving higher, and what is moving lower. While it may be a bit extreme to make all your investing decisions solely based on technical analysis, a basic understanding of what is trending in which direction is helpful to anyone.

Financial and commodity stocks have led the markets higher for the last several years. Take a quick glance at a longer term chart of Bear Stearns (BSC) to see a long continuous trend going back to 1998 that has only recently been broken, or a similar uptrend in Goldman Sachs (GS) starting in 2003. Take a glance at Exxon Mobile (XOM) to see a strong trend, still intact, starting in 2003 or Schlumberger (SLB), also starting from the same time. Since these stocks have been in such powerful trends, they have become overweight in such indexes as the S&P 500, which as of June 30, possessed a 20.77% weighting in Financial stocks, which is obviously why, when these stocks falter, it tends to bring the general market down with it.

The argument that this may end up being a sector rotation is a valid one. Unlike the financials and energy, other sectors such as technology or biotech have not enjoyed such stellar runs and may be due their time in the limelight. Quite the opposite of the chart of Goldman Sachs, semiconductor behemoth Intel (INTC) has been stuck in a consolidating trading range and debatable down trend since its 2000 peak. Microsoft (MSFT) is the same price today as it was in November 1998, October 2000 and a few times in 2001 and 2002, the point being the stock has done zilch. Cisco (CSCO) only recently saw prices not seen since January 2004 and Juniper (JNPR) is also consolidating around a level last seen in January of 2004. Rather than strong uptrends, these stocks have been moving sideways at best, and the argument that it may be their time is valid, but still yet to be seen.

If in fact this is a rotation, it is important to understand it will remain choppy simply because of the sector weightings in the broad averages. For example, regardless of how well Microsoft is doing one day, if Exxon Mobil is struggling, more than likely the S&P will be hit. This is simply because Microsoft makes up 1.86% of the S&P whereas Exxon Mobile makes up 3.54%.

The other issue we are dealing with is psychology and investor sentiment. If the general market is sagging, it will be tough to get other stocks moving, as the broad market tends to set the tone. Despite how optimistic I may be that a particular stock may do well, if others that are rotating out of favor are suffering, it may take quite a while for a stock to actually perform as it should.

Simply because certain stocks have been trending higher and may now be starting a new trend and others have been moving sideways and may start to be heading higher doesn't make it so, and investors should be well aware of the fact that it may be we are actually entering a bear market where nothing works. Because that is a real possibility we should wait it out rather than jump to conclusions one way or the other. Those who fear missing the boat should simply review those previous leading trends to see just how far they can go when a sector is really in favor and to take refuge in the fact that missing the boat is highly unlikely.

The jury is still out on whether or not this is a nasty rotation, a brief stumble for previous leaders who will once again take the reins, or the start of a bear market altogether. I continue to understand and watch for all possibilities to play out, but watching is the key word. I figure each possibility carries an equal weight, which means to subscribe to one thesis gives me a 33% chance of being right. Some may like those odds, but I find them hardly in my favor. I would much rather know a trend has set in, and jump aboard when I am sure of the direction in which we are traveling.

Futures are pointing to a slightly negative open this morning. The mood on the Street seems lethargic at best and I suspect many, like me, are ready to call it a week.
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