Hello Fellow Chart Watchers!
Wow! This week's issue is our longest yet! I apologize to the people with slow links, but I'm sure you'll find all of the info here useful. If you want to skip ahead, here are links to Site News, Richard Rhodes', and John Murphy's commentary. Now, on with the show...
With the market picture largely unchanged - the Nasdaq is still struggling with 2250, the Dow with 11,000 - I thought we'd turn our attention to the bigger picture this week. Specifically, Sector Rotation.
Since the days of my original website (anyone remember "Chip's Charts"?), I've continuously tracked how the nine major S&P sectors did relative to one another. The idea - based mainly on S&P's chief analyst Sam Stovall's work - is that as the US economy cycles between recession and recovery, various sectors of the stock market will rise and fall relative to the market as a whole. Since, as a group, investors try to predict the economic cycle, the stock market rises and falls ahead of the the economy. Using lots of historic data, Stovall came up with theoretical model the connects the major stock sectors with various points in the general market cycle. Several years ago, I refined his original work somewhat so that it ties in with the S&P Select Sector SPDRs - nine "stocks" that trade on the Amex but whose value is really tied to the performance of the sector that they represent.
Our Amex Sector SPDR PerfChart was specifically created to help you discover and track rotation effects. Unlike our other PerfCharts, this one is initially displayed in histogram mode with sectors arranged in the order given by Stovall's model. Each bar represents the performance of a sector during a 65-day period. Moving the slider at the bottom allows you to "window" through the dataset as far back as 1998. In order to see whether each sector is outperforming or underperforming the market as a whole, the S&P 500 index is subtracted from each bar, making it the "baseline" of the chart. Just below this chart, we include a graphical view of the rotation model for reference. A blue box on the model shows were I personally think we are in the current cycle.
So, does this stuff work?
In my opinion, we are just now finishing the first full "pass" through a complete market cycle since the S&P Sectors SPDRs were created in late 1998. The charts below show how things have progressed during that time. I realize that there are a lot of charts here, but stick with me as we revisit key moments during this past cycle...
In mid-1999, Tech stocks were king. The Technology SPDR was outperforming every other sector by almost 18% and was outperforming the S&P itself by almost 16%. No other sector was outperforming the market at that time.
The sector model says that Tech stocks do best at the start of a new bull market just as the economy is starting to come out of a recession. While that was not exactly the case in 1999, you must remember that the model represents an idealized time line - in reality the red and green curves are stretched and compressed as some phases of the cycle take longer than others.
In an example of this stretching, we see that not much changed through January of 2000. Tech stocks were even stronger than before, although Cyclicals and Basic Industry were starting to outperform the market. Notice that I moved the blue box on the model to the right, but not by much.
By mid-April things changed pretty dramatically. For the first time in more than a year, the Tech sector was underperforming the market as a whole. As the model predicts, the Industrial and Energy sectors were showing signs of life but - as is the case with most financial models - things were not cut and dried. There was continued weakness in the Basic Industry sector as well as unexpected strength in the Financial sector. I moved the blue box further to the right, but I wasn't entirely confident about its location at this point.
Confirmation! Just a couple of weeks later, the Energy sector exploded upwards and the Basic Industry sector improved significantly. The blue bar continued its march to the right, this time with a bit of a swagger. ;-)
Hmmmm... This is typical of the kind of quandary that Sector Rotation analysis often presents you with: Should we stick with the steadily growing strength in the Consumer Staples area (blue box) or skip ahead a couple of slots due to the strength in the Utilities (red box)? I chose the more conservative approach (blue box), but I didn't feel good about it.
By the end of the year 2000, we see a picture that is almost the exact opposite of the first chart in this article. The Tech stocks were underperforming and everything else was outperforming the market. While the Consumer Staples sector wasn't leading the way (Basic Industry turned out to be a late bloomer), it was significantly higher than it had ever been and therefore it got the blue box for now.
Note that at this point the model indicates that the market was past its top and that the economy would also top out soon. Now obviously, since the market topped in May 2000, this model on its own is a pretty poor timing tool. However, it did signal to savvy long-term investors that there was no "quick-fix" on the horizon for stocks.
One month later the Cyclical/Transports sector was the big winner with the Financial sector continuing to ourperform like it had since the Tech sector collapsed. Interestingly, the Tech sector's slide had also slowed at this point. The blue box marched on...
That brings us up to today. For the first time in more than a year, the Tech sector isn't dramatically underperforming the market. And with the big run by Cyclical/Transports just about over, I've moved the blue box back to where it was when we started this journey. The longer-term message is that the bottom is in sight and renewed strength in the tech sector would signal the start of the next bull market. It also implies that investors will have lots of time to join in on the next big upleg, one of the reasons I'm still urging patience as the major averages wrestle with their current resistance zones.
As you probably noticed, there is lots of room for different interpretations in this kind of analysis. There are also several variables that can be adjusted to provide different results. For example, I use a constant 65-day period throughout but other durations may be just as valid. Using the S&P 500 as a proxy for the market as a whole may not be as valid as it used to be. Etc. etc. etc. That's why StockCharts.com gives you the tools to adjust these variables and come up with your own analysis. I urge you to visit the Amex Select Sector SPDR page and experiment with things first-hand.
- Chip Anderson
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| The Rhodes Report Summary
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Richard's thoughts on the market continue to evolve. For more on his views, including specific buy/sell advice, visit Richard's website - http://www.therhodesreport.com.
Questions? Comments? Concerns? Problems? Suggestions? Simply 'r'eply to this email message and I'll see what I can do.
If you have any problems, simply 'r'eply to this email and
I'll try to fix things by hand.