Sector Relative Strength

Week Ending 12/05/2008

In today's Sector Relative Strength investigation we find a short- and long-term reversal.  We are seeing some short-term rotation from defensive names to the more economically sensitive names.  As we review the sectors today, I will make reference to the Sector Rotation Circle discussed on November 24.
The Long View
In Figure 1, I show the 6-month performance of each sector relative to the S&P 500.  A positive number means that the sector outperformed the market by that percentage.  Each column looks back 1 month as a snapshot for comparison.
Figure 1
Six-Month Sector Performance Vs. S&P 500, Monthly
I've sorted the table on the 12/5/08 column.  The first thing to notice is the Consumer Staples, XLP, performance over the past 12 months or so.  In November, 2007, the six-month performance of XLP edged out the market by almost 2%.  The Staples continued to outperform over the following 13 months, culminating in a current 6-month outperformance of almost 20 percentage points better than the market.  This is the type of behavior we would expect during the late expansion/early contraction phase of the economic cycle.  Coincidentally, a report from leading economists declared that the US recession officially started in December, 2007.
Looking at the other defensive sectors, Health Care (XLV) and Utilities (XLU), we see similar patterns.  XLV and XLU began to outperform a month after Staples.  Except for a few blips, these groups have had better-than-market 6-month performance ever since.
On the downside, we find that Metals & Mining (XME), Materials (XLB), Energy (XLE), and Financials (XLF), have deterioratied considerably over the past 16 months.  The XLF, for example, has delivered a negative return for all 16 months, with 13 of them worse than -10% underperformance.  Until September, 2008, the Energy and Materials groups were among the best performers.
This may be expected, given all the turmoil in the credit markets, but there may be another explanation as well.  Looking back at the Sector Circle, we see that Financials are on the opposite side from Basic Materials.  This is sort of like complimentary colors on the color wheel.  When commodities, in general, are doing well, interest rates tend to be relatively high.  That is normally bad for financial stocks.  The abberation here is that interest rates have fallen considerably over the past year, and financials do not appear to have moved much.
The Short View
We now turn to a 2-week performance analysis.  Figure 2 shows the same sector ETFs, and their relative performance to the S&P 500 over the past 2 weeks.  Each column now looks back 2 weeks, also.
Figure 2
Two-Week Sector Performance Vs. S&P 500
Over the past 2 weeks, the Financials (XLF) and Consumer Discretionary (XLY, also called Consumer Cyclicals), have handily beaten the general market by 20% and 12.7%, respectively.  The defensive names are all now the worst performers, underperforming by between -7.8% and -9.5%.
Another view of the Staples vs. Cyclicals battle can be seen in a simple ratio chart:
Figure 3
Two-Week Sector Performance Vs. S&P 500
After weak performance by the cyclicals through the end of November, they have bounced in the near-term pretty impressively.  Further movement in the current direction is bullish for stocks.
Two weeks is a short-term view, but we do see a very obvious rotation of funds.  This may only be temporary, and a result of the recent bear market rally starting just befor Thanksgiving.  Nonetheless, the flag of rotation has been raised, and if this trend continues, it means we are in for much more upside.