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Renewed leadership by the sectors that stand to benefit most from a stronger
economy and profit growth down the road…could be one of the best indications that perhaps the worst is indeed behind us and the rally has more room to run. However, if these cyclical sectors fail to participate more fully, that would be a signal of more potential trouble ahead. [Let me explain.] Words: 840
So says Mike Burnick (www.moneyandmarkets.com) in edited excerpts from his original article*.
Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!) has edited the article below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.
Burnick goes on to say, in part:
For the third straight August, investors are facing widespread uncertainty:
- the approaching fiscal cliff,
- a global economic slump,
- upcoming U.S. elections,
- Europe’s never-ending debt crisis and
- a persistent drum-beat of headline risks about how the European Union can possibly solve its debt woes.
The predictable result has been another summer of volatile markets, with the Dow Jones Industrials on a roller-coaster ride — diving more than 800 points in the month of May alone, followed by a whipsaw 700-point-plus rebound since June’s low.
The Risk-ON vs. Risk-OFF Indicator – The Ultimate Sentiment Indicator
It’s been… a “Ro-Ro” market as the pendulum swings relentlessly from risk-on to risk-off mode and then back again. It’s really no surprise why investor sentiment appears so depressed at the moment…and there are still plenty of lingering concerns that could send jittery markets into another tailspin.
To help provide clues about the stock market’s next potentially major move…[I’ve developed] a custom indicator [- I call it the Ro-Ro Indicator (see below) -]…that’s a good gauge of whether positive or negative sentiment has the upper hand in the stock market. I simply take the values for the Standard & Poor’s Consumer Discretionary stock index and divide by the S&P Consumer Staples stock index.
[The Ro-Ro Indicator] is a handy comparison that shows how well consumer discretionary stocks like Amazon — that are more cyclical and dependent on consumer spending — are performing compared to staples like say, Proctor and Gamble, which tend to be steady market performers regardless of the economic outlook.
- consumer discretionary companies had the upper hand in terms of market performance from September 2011 through this past April when the S&P 500 Index gained 19.3% overall.
This was clearly a risk-on period in markets, when aggressive stocks and commodity investments outperformed more conservative strategies.
- earlier this year, however, consumer staples outperformed discretionary companies by a wide margin. Over this period, the S&P 500 has been a lot more volatile, posting a total return of just 1.9%.
The current direction of this indicator tells me that over the past several months, risk-off mode has been the dominant trade of the day.
Overall, the S&P 500 Index is up more than 11% year-to-date, a surprisingly good performance given the volatility we’ve witnessed. Still, it’s clear that many investors remain unconvinced, as stocks climb the proverbial wall-of-worry…pulling $71 billion out of U.S. stock mutual funds so far in 2011, even as the market has moved quietly higher!
Considering this one-sided negative sentiment, it’s quite possible that a fair amount of bad news has already been priced into the markets at this point, a potential positive.
On the other hand, however, those who do remain invested are acting very cautiously with their stock selection at present, favoring defensive sectors like telecom, health care, and yes, consumer staples and this raises a red-flag on the markets in my mind.
What Is Needed to Move the Market Further Upwards
If the bullish move in domestic stocks since June is to continue, I would expect:
- the rally to broaden out to more economically sensitive, cyclical stocks and sectors such as technology, industrials, and of course, consumer discretionary companies.
In other words, I’m looking for renewed leadership by the sectors that stand to benefit most from a stronger economy and profit growth down the road. In fact, stronger performance from these names could be one of the best indications that perhaps the worst is indeed behind us and the rally has more room to run. However, if these cyclical sectors fail to participate more fully, that would be a signal of more potential trouble ahead.
Consumer Discretionary vs. Consumer Staples: the Clue to Market Direction
Since my focus is investing in exchange traded funds I’m watching the SPDR Select Sector Consumer Discretionary (XLY), and the SPDR Select Sector Consumer Staples (XLP) for clues as to whether the current risk-off climate will continue, or reverse back to favor risk-on trades again.
XLY is up 12% so far this year but lately it has been struggling to keep up the pace as shown in the chart below.
XLY has been locked in a sideways trading range since June, even while other more defensive ETFs have outperformed it. This tells me investors are still clinging to a risk-off mentality, and aren’t as enthusiastic about stocks that would benefit from a pickup in the economy.
Conclusion
If XLY can break out above its recent highs, however – and resume its leadership role – this could signal a return of the risk-on trade in markets, which could help sustain this rally. Stay tuned!
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*http://www.moneyandmarkets.com/for-clues-to-market-direction-watch-my-favorite-ro-ro-indicator-50168 (To access the above article please copy the URL and paste it into your browser.)
Editor’s Note: The above posts may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.
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