ROTATIONS CONTINUE - FROM TECHS TO INDUSTRIALS -- FROM SMALL TO LARGE -- FROM RETAILERS TO ENERGY
DOW OUTPERFORMING THE NASDAQ... Over the past few weeks I've spoken about several rotations that are going on within the stock market. One of the most obvious is the new preference for industrial stocks over technology stocks. That can be seen in Chart 1 which plots a ratio of the Dow Industrials divided by the Nasdaq Composite Index. Ratio (or relative strength) charts are the best way to spot these rotations. Chart 1 shows the Dow/Nasdaq ratio rising to the highest level in four months. Throughout the past year, the Nasdaq has outperformed the Dow. Since the start of December,some money is rotating out of technology into industrial stocks. That rotation has also been seen on several recent days when the Dow gained ground while the Nasdaq has dropped. There are several other rotations going on.
Chart 1
FROM SMALL TO LARGE CAPS... Another recent rotation that's taking place is money moving from small to large cap stocks. That can be seen in Chart 2, which plots a ratio of the S&P 600 Small Cap Index divided by the S&P 500 Large Cap Index. All year the small caps have been leading large caps. Since the start of December, the ratio line has started to rise. That suggests that money managers are moving some money back into large-cap stocks. That's also consistent with the move into industrials, which tend to be bigger stocks.
Chart 2
ETF SECTOR LEADERS... We're going to be using sector ETFs (which are traded on the American Stock Exchange) to demonstrate where money has been moving to lately. And then we'll show you where it's been leaving. Chart 3 through 6 show the four top sector ETFs since the start of the fourth quarter -- in order of their relative strength. [The ratio lines under each chart divide the sector ETF by the S&P 500]. Materials are the strongest sector. The relative strength line shows that this group started to outperform during July (when commodity prices resumed their uptrend). Although this group has maintained its leadership, it's beginning to look overextended. The next best performer this quarter is Energy. This group has just broken out to the upside. And its relative line just turned up in December. This is new leadership. Industrials also started to outperforming during July. The ratio line turned up again in late October and has just exceeded its August high. [Over the past week, Industrials were the top sector]. Utilities have just started to rise in the sector rankings. Utilities were the fourth best sector group during the fourth quarter. The relative strength ratio is just starting to bottom. But it's worth keeping an eye on.
Chart 3
Chart 4
Chart 5
Chart 6
ETF SECTOR LAGGARDS... When money rotates into one sector, it has to come out of another. Since the start of 2003, Technology and Consumer Discretionary ETFs have been the two strongest market sectors. During the fourth quarter, their relative performance has fallen. [Technology has been the weakest sector during December]. The relative strength line in Chart 7 has started to drop, which shows loss of leadership by Technology. The falling ratio line in Chart 8 reflects rotation out of Consumer Disretionary stocks. This group is dominated by retailers and homebuilders, which have been falling of late.
Chart 7
Chart 8
DONT LEAVE -- JUST ROTATE... Most market discussions have to do with the direction of the stock market. As important as that is, it's not always the most important thing. It's not aways a matter of whether or not to be "in the market", but "where". The ratio charts plotted above show that money is rotating within the stock market out of former leaders and into former laggards. That's the work of money managers. One of the reasons we do market analysis is to track what the institutions are doing. That's because they have huge influence on the market. If they're doing the rotating, it's not a bad idea to do some of the same.
