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Message: The Lead-Lag Report:
The Lead-Lag Report: Looks and Smells Like a Bull
By Michael A. Gayed Jan 17, 2012 11:10 am
This week's Lead-Lag Report further confirms that the bulls are in charge, and market internals are signaling more bullish news is coming.
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.
LEADERS: ALL KINDS OF BULLISH Financials (XLF) – Breakout and Trend Confirms Bullish Environment Comments: After a significantly long period of weakness in Financials driven by debt concerns over Europe, the ratio finally appears to have bottomed in December 2011 and is now in the early stages of an uptrend. Last week's outperformance is particularly bullish given the new of S&P's downgrade of nine eurozone countries and earnings released by JPMorgan (JPM) which were in line with expectations. Continued strength in the sector all year is likely necessary for the bullish tone to continue and for equities to rally to potentially new highs. Recent outperformance could feed on itself if investors begin to get the feeling that the worst may indeed be over, and reflation is the thing to position for going forward.
Materials (XLB) – No Longer Boring
Comments: Materials, much like Industrials, received a nice boost of strength last week and a new trend in leadership appears to be forming as investors bet on reflation and a comeback in emerging markets. It is worth noting that if Commodities (DBC) begin to resume their longer-term uptrend because of a recovery in Housing (XHB) here in the U.S. and potential improvement in China's (FXI) market, the Materials sector strength could continue and easily be justified on a renewal of demand by countries for raw materials. It will be interesting to see if the ratio can recoup to pre-Summer Crash 2011 levels. Emerging Markets (VWO) – Bottoming Process? Comments: We may be at a very important juncture as it relates to Emerging Markets which substantially underperformed U.S. markets last year.
I have noted before that a bottom appears to be forming in countries like China (FXI), Russia (RSX), Brazil (EWZ), and India (INP) and with the possibility of a pickup in global growth coming, beaten down emerging market stocks likely have enormous potential to outperform this year in a 2012 reflationary environment. Notice how far away the ratio is from pre-Summer Crash levels, with any kind of a run back to those levels a big move potentially to exploit in the months ahead.
LAGGARDS: BEAR TRADE CONTINUES TO WEAKEN Consumer Staples (XLP) – Underperformance Signals More Bullishness Comments: I noted last week that "continued weakness into the end of this week would indeed be a very positive sign for the bulls, as volatility declines and animal spirits possibly return with a vengeance." Weakness did indeed continue in the sector as it failed to keep up with the S&P 500 (IVV). While entirely possible for the ratio to retest its 20 day (1 trading month) moving average in the next couple of weeks, it does appear that the uptrend is now definitively broken as animal spirits return to markets and a bullish environment causes money to begin to chase higher beta stocks and not less-cyclical Consumer Staples.
Utilities (XLU) – From Income to Capital Appreciation?
Comments : Given the sensitivity of the highly leveraged Utilities sector to the future direction of interest rates, and the general move into the group when investors favor income over capital appreciation, last week's continuation of weakness further confirms a bullish environment for risk and the idea that the Winter Resolution may indeed be an uptrend after all. I fully suspect that the sector will recoup some of its underperformance in the coming weeks, but the trend down appears fairly entrenched at this point as the fever breaks in Europe and markets begin to anticipate the end of bad news (which is good news). While Utilities were a star performer last year, 2012 may result in a completely new set of sector leaders. Europe, Australasia, and the Far East (EFA) – Nearing the Bottom?
Comments
: Last week I noted that "much of this weakness may be attributable to a strong dollar/weak Euro given that EFA is denominated in dollars, and has a negative currency effect as a result. Having said that, the ratio's decline may be overdone, whereby international markets could certainly begin to outperform the U.S. on a pure mean-reversion trade. From an equity allocation standpoint then, EFA might provide an opportunity to outperform in the coming weeks." While weakness did persist, the ratio did not make new ratio lows and may be at a relative bottom now that the Downgrade Rampage could be nearing its end. Don't count out other developed markets just yet – a mean reversion trade may yet be coming.
Great bull markets tend to occur when nobody is expecting it, and when strength persists in the face of negative news.
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