SECTOR ROTATION MODEL SHOWS WHERE MONEY GOES AROUND MARKET TOPS -- UPTURN IN RELATIVE PERFORMANCE OF STAPLES AND HEALTHCARE WARNS OF MARKET PULLBACK -- KRAFT FOODS AND SAFEWAY BREAKOUTS -- BRISTOL MYERS HITS NINE-YEAR HIGH
THE SECTOR ROTATION MODEL ... My Tuesday message talked about how sectors rotate near market tops. I explained that market leadership by materials and energy (which carries inflationary expectations) is often a sign of market that's in need of a correction or a consolidation. I also explained that money coming out of those two leading sectors usually rotates into defensive sectors like consumer staples and healthcare. Chart 1 is a visual representation of how that happens. The red line plots the stock market while the green line tracks the economy. Our main interest here is with sectors which are plotted along the top of the chart. You can see that Basic Industry (materials) and Energy are late cycle leaders. Tops in those two groups usually coincide with the start of a market correction or consolidation. When that happens, leadership swings to Staples and Services. [The Model is based on the work of Sam Stovall of Standard & Poors. In my 2009 book, The Visual Investor (Second Edition, p. 208), however, I changed Services to Healthcare which makes more sense]. As I explained on Tuesday, materials and energy were the two top sectors entering the month of April. Over the last week, energy and materials have reversed to the two weakest sectors. Right on cue, staples and healthcare have reversed to the two strongest. That doesn't necessarily mean that a major top is forming. It does suggest, however, that market sentiment has turned more defensive which usually suggests a market correction or a period of consolidation.
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Chart 1
DEFENSIVE ROTATION ... Chart 2 shows how those two defensive sectors work relative to the broader market. The green line plots the S&P 500 over the last three years. The red line is a "relative strength ratio" of the Consumer Staples SPDR (XLP) divided by the S&P, while the blue line shows the "relative" performance of the Healthcare SPDR (XLV). The ratio lines usually trend in the opposite direction of the market. During the market meltdown of 2008, notice that the two defensive sectors held up much better than the S&P. Since the spring of 2009, when the market bottomed, staples and healthcare have underperformed. Defensive sectors underperform during market uptrends, and outperform during market corrections. Chart 3 gives a closer look at the two relative strength ratios since last September when the last market upturn started. Both defensive ratios have broken a seven-month down trendline which is a potential warning of some market weakness. The best way to hedge against that is to buy into either or both of those defensive groups. Both defensive groups also pay dividends which provides an added cushion against market weakness. That's especially helpful to conservative investors who are being forced to flee the bond market because of rising inflation pressures but are nervous about buying stocks.
Chart 2
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Chart 3
SAFEWAY AND KRAFT FOODS BREAKOUT... A scan of the consumer staples sector carpet turned up these two stocks that have just completed bullish breakouts. The daily bars in Chart 4 show Safeway (SWY) having just broken through its November high. Chart 5 shows Kraft Foods (KFT) having just done the same. That's not the only upside breakout KFT has achieved. The monthly bars in Chart 6 show Kraft having cleared its 2007 peak near 32. Relative strength lines are just starting to turn up. For whatever the reason, investors are flocking to this defensive group.
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Chart 4
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Chart 5
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Chart 6
BRISTOL MYERS AND PFIZER SHOW VALUE OF MONTHLY CHARTS... The easiest way to buy into the healthcare sector is through the Healthcare SPDR (XLV). Although several biotech stocks have done well of late, that group carries a relatively small weighting in the XLV (10%). Big pharma carries the biggest weight by far (48%). That why I tend to favor that group whenever I recommend healthcare, and why I featured Pharm Holders (PPH) on Tuesday. For those wishing to buy individual stocks, two of the big pharma stocks are achieving bullish breakouts of their own. The current leader (and favorite) is Pfizer (PFE). Charts 7 and 8 show why. They also show the importance of chart "perspective". The daily bars in Chart 7 show Pfizer having exceeded its early 2010 high near 19. Its relative strength line (below chart) has also been rising. Unfortunately, some casual observers might look at Chart 7 and decide that Pfizer is too "expensive" to buy at this point. The monthly bars in Chart 8, however, show the opposite to be true. In fact, Pfizer looks "cheap" on its longer-range chart. Chart 8 shows that the stock has just started to form a bullish pattern of "higher highs and higher lows". More importantly, it has also broken a ten-year resistance line. It's also a big dividend payer. That makes for a healthy combination. The monthly bars in Chart 9 show Bristol Myers Squibb (BMY) trading at the highest level in nine years after having exceeded its 2007 high. Chart 9 is another example of why it's important in chartwork to keep an eye on long-term monthly charts and not rely exclusively on daily charts. For conservative investors looking to commit some money to the stock market (or for those looking to rotate to a relatively safer group), healthcare appears to be a good choice on both counts. So are consumer staples.
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Chart 7
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Chart 8
