Sectors and Industry Groups to Avoid or Embrace
- Fading Sectors/Industries: Financial, Homebuilders, Consumer, Biotech, Small Cap, Industrial
- Emerging Sectors/Industries: Energy, Mines, Basic Materials, Gold Miners
Sector rotation is a continual process, but recently several old favorites have started to lose favor, and several previously discarded ones are coming to the fore. I am going to run through some of what I consider to be some of the key ones.
Nirvana Template
To do this I use what I call my Nirvana template. I call it that because in one chart I can get all the basic information I need in four chart windows. The top panel features the absolute price based on Friday closes. The second, features a long-term smoothed momentum (KST) indicator, which has been designed to give perspective on the direction and maturity of the primary trend.
The lower windows contain relative action in the form of the RS line against the S&P Composite and a long-term smoothed momentum (KST) of relative action. Both the price and the RS line contain 65-week EMA’s, a time span that seems to work better than most, though it’s certainly not perfect. Overall it offers a pretty complete picture of the long-term technical picture for the security in question.
Ideally potential purchases are made when both KSTs are reversing from a low level and this is confirmed by a trendline break/positive EMA crossover by the price/RS line: Even better if the short-term momentum is not overbought! Sales should be considered when these conditions are reversed where momentum is rolling over and confirmed by up trendline violations or negative 65-week EMA crossovers.
An example of this Nirvana template for the Dow Jones Financial ETF (IYF) is shown in Chart 1, where a great buying point has been flagged for October 2012 . In this instance both the price and relative action began to go positive. The indication was not just that financials would rally on an absolute price basis, but that they would out- perform the S&P in the process. What we do not know is the magnitude and duration of the expected price move.
Chart 1
Incidentally you can save this arrangement as your own Nirvana template by clicking on the chart, eliminating the comments and lines through the annotation process, and saving the result as a ChartStyle.
Sectors falling out of favor
Fast forward to Chart 2, where you can see that the IYF is still in an uptrend as the bull market trendline remains intact. However, momentum has started to keel over. The weakening KST is not an actual signal to sell, rather it warns that the underlying trend is starting to deteriorate, so the odds of a trendline break have started to increase. The relative action has violated a trendline and is below its EMA. Bottom line, even if the price does continue to rally the weakening relative action tells us that there are better places to park money.
Chart 2
That’s also the message we get from the consumer discretionary sector in the form of the IYC in Chart 3. The uptrend for this sector is still intact, but a bearish absolute momentum and weak RS and RS KST suggests that there are better alternatives.
Chart 3
Homebuilders, in the form of the Spider Homebuilders ETF, the XHB, is hanging on by a thread in the form of a potential 2013-2014 head and shoulders neckline. Momentum is bearish, but the most negative factor of all is the drop by the RS line to a new bear market low. Quite often when an RS line is as weak as this it is soon followed by the price itself. Since homebuilders are a leading sector, completion of that potential head and shoulders top seems a logical outcome.
Chart 4
Biotech, in the form of the Market Vectors Biotech ETF (BBH) is another area that appears to have lost its mojo. Both the price and the RS line recently violated 18-month up trendlines and both KSTs have gone bearish by crossing their EMA’s and remain very overextended. That probably means that the recent rally is likely to find resistance at the two extended lines.
Chart 5
Finally, the Russell 2000 in the form of the IWM remains above its EMA and bull market trendline. So too does the RS line. Both could be in the process of completing tops. The IWM itself would certainly do so with a Friday close below $107. This sector needs to be watched very closely since the trendline for the price goes back to 2009 and both KSTs are already bearishly below their EMA’s.
Chart 6
Sectors coming into favor
On the bullish side we see several earnings driven areas emerging. Chart 6 for instance, shows that the Spider Metal and Mining ETF, the XME, has tentatively broken above key trendlines on both an absolute and relative basis. Both KSTs are also in the early phase of a rally, so more decisive. trendline violations are likely. The Global X Copper Miner ETF (COPX) is showing similar characteristics, though the breakout for this ETF is much stronger.
Chart 7
Chart 8
The energy sector has been in a bullish trend for quite some time as shown in Chart 8 for the Dow Jones Energy ETF (IYE). However, it appears to have gained a new lease on life with a break above the green resistance trendline. Also, relative action has just completed a base and its momentum has just gone bullish again.
Chart 9
Materials also look positive since the Dow Jones Basic Material ETF, the IYM, recently broke to an all-time high. The RS line is still below a resistance trendline but the positive action of relative momentum suggests that it will soon break through.
Chart 10
Finally, gold and silver equities have started to improve with a tentative breakout for the GDX and a decisive one for the SIL. Relative action also looks encouraging.
Chart 11
Chart 12
In conclusion, we see weakness in what are generally regarded as leading sectors and strength in those stocks that tend to do better during the tail end of the cycle.
If you want to learn more about using the KST as well as my other technical indicators and charting techniques, join me in Seattle in 3 weeks at ChartCon 2014. Click here to register. I'd love to see you there.
Good luck and good charting!
Martin Pring
