STRONG RETAIL CHARTS ANTICIPATE JUMP IN NOVEMBER SALES -- ABERCROMBIE BREAKS OUT -- FINANCIAL BOUNCE SUGGESTS DEBT CONCERNS ARE EASING -- SECTOR ROTATIONS FAVOR ECONOMICALLY-SENSITIVE STOCK GROUPS AND SHOW GROWING OPTIMISM
ABERCROMBIE & FITCH BREAKS OUT ... My Tuesday message wrote about the fact that retail stocks have been showing market leadership since midyear, and that several individual retailers were achieving bullish breakouts or were close to doing so. One that I highlighted was Abercrombie & Fitch (ANF) which was challenging its spring high. That stock reported a 22% jump in November same store sales and is the top percentage gainer in S&P 500 in early trading. Chart 1 shows the stock gapping through its spring high (to the highest level in two years). Two other stocks that I showed with strong chart patterns -- Gap and Macy's -- also beat expectations. The jump in retail earnings reported today is being cited in the media as one of the bullish fundamental factors driving stocks higher. Two points are worth noting having to do with the nature of technical analysis versus economic forecasting. One of the basic premises of TA is that market action discounts (or anticipates) fundamental and economic trends. That's true of individual stocks (like ANF) or entire sectors (like retailers). I suggested on Tuesday that the strength in retail stocks was a positive sign for the US economy and the stock market as a whole. I also suggested that a tug of war was going on between an improving domestic economy and foreign debt problems. While retail strength reflects the improving domestic economy, weakness in financials has been symptomatic of foreign debt problems. The fact that financials are today's strongest sector suggests that debt problems may be easing as well.
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Chart 1
FINANCIALS BOUNCE IMPRESSIVELY -- BROKERS LEAD ... Financial stocks have been the market's weakest since the spring. They've also fallen the hardest over the last month owing primarily to European bank debt problems. That's why today's strong rebound is ecouraging for that group and the market as a whole. Arthur Hill's message yesterday showed the Financial SPDR (XLF) and Bank Regional Holders (RKH) bouncing off chart support along their autumn lows. Today's strong rebound is even more impressive. Chart 2 shows the XLF jumping back over its 200-day moving average. Chart 3 shows a 3% gain in Bank Regional Holders close to doing the same. That's the first sign of financial leadership in a month when the European debt crisis first surfaced, and is certainly a positive sign for the U.S. stock market. So is the fact that brokerage stocks are leading the financial rally. Chart 4 shows the Dow Jones US Broker Dealer iShares (IAI) bouncing impressively off chart along its 200-day average and August high. It's hard to imagine the US stock market rallying without help from financial stocks, and brokers in particular. The fact that brokers are leading the financial group higher also shows that the mood on Wall Street is improving.
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Chart 2
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Chart 3
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Chart 4
SECTOR ROTATION SHOWS BULLISH ENTHUSIASM... Another way to determine whether or not investors are turning more optimistic on the economy (and stock market) is to study the trend of recent sector rotations. In an improving economy, investors tend to favor economically-sensitive stock groups. In a weakening economy, they favor defensive stock groups. Charts 5 and 6 reflect a much more upbeat mood on the American economy. Chart 5 shows relative strength lines for four economically-sensitive stock groups since midyear, and show all four groups rising faster than the S&P 500 (flat black line). In order of strength, they're energy, transports, small caps, and semiconductors. It's always a good sign when those groups are leading the market higher. By contrast, Chart 6 shows the three weakest groups since August to be healthcare, utilities, and consumer staples. Investors rotate out of those defensive stock groups in a strengthening economy.
Chart 5
Chart 6
NOT ALL BONDS ARE THE SAME... With interest rates starting to rise (along with stocks), investors are starting to move money out of bonds and into stocks. While that's a smart move in a strengthening economy, be advised that all bonds aren't equal. Chart 7, for example, shows three popular fixed income ETFs since March 2008. During the financial collapse of 2008, the two worst bond categories were high yield (black line) and investment grade corporates (blue line). By contrast, long Treasuries (red line) were the strongest. Compare that to Chart 8 which shows those three bond categories reversing roles after March 2009 when the stock market bottomed (and the recession ended a few months later). In that stronger economic environment, high yield (junk bonds) became the strongest bond category followed by investment grade corporates. The long Treasury became the weakest. So here's the moral to the charts. In a weak economy, the long Treasury bond is the best haven. In a strengthening economy, however, the long bond becomes the worst bond category to hold. The two best are high yield and investment grade corporates (and in that order).
Chart 7
Chart 8
BUT STOCKS ARE BETTER THAN ALL BONDS ... In a strengthening economy (and rising stock market), it's true that some bond categories (high yield and and investment grade corporates) hold up better than other fixed income groups. It's also true, however, that a rising stock market usually does better than "all" bond categories. Chart 9 shows three of this year's strongest bond ETFs "relative" to the S&P 500 (flat black line) since March 2009. During the stock market rally from March 2009 to this April, all three bond categories underperformed stocks. They include high yield (HYG), investment grade corporates (LQD) and TIPS. During the stock correction from this April through August, all three bond ETFs outperformed stocks. Since September, all three are lagging behind stocks once again. The message there is twofold. In a strengthening economy with rising inflation expectations, corporate bonds and TIPS usually hold up better than traditional Treasury bonds. However, stocks usually do better than all bond categories. That's why it's a good idea to start moving some money out of bonds and into stocks if you haven't already done so. Money remaining in bonds should be concentrated in corporate bonds and TIPS.
Chart 9
STOCK INDEXES BACK IN UPTREND... The last two days' jump in stocks leaves little doubt that the pullback has ended. Chart 10 shows the S&P 500 SPDR (SPY) trading at a three-week high after bouncing off its 50-day average (blue line). In addition to strong technicals, the market has cyclical and seasonal trends in its favor. December is traditionally a strong month for the market. Stocks have the four-year midterm cycle acting as a tailwind as well.
