New Evidence Suggests A Change In Market Leadership Is Underway

• The US market viewed from abroad
• Resource based sectors in general are under-performing
• Defensive sectors are generally improving
• Ratio between a late and early performing sector is at a critical juncture

Back in August I wrote an article pointing out that we might be in the early stages of a leadership shift away from earnings driven sectors to more defensive and interest rate sensitive issues. The evidence was fairly sketchy at the time, but recent price action reinforces the idea that such a switch is underway. When I talk about “leadership” the reference is more about relative than absolute price action. For example, during the 2000-2002 bear market, consumer staples declined in absolute price terms, but they were very strong relative strength performers.

The US market viewed from abroad

Before we take a look at the technical position of the various sectors, I thought it would be interesting to take a look at the S&P as seen through the eyes of a Euro-based investor. In this respect, Chart 1 shows that there have been five distinct trends since 1994. A reversal in each was signalled by a trend line break. The latest rally has resulted in an unhedged gain of 400%. The small dashed red arrows indicate the futility of using KST reversals as a sell signal. The trend has been far too powerful for that. At present the euro adjusted S&P is comfortably above its 12-month MA and bull market trend line, so there is no sign at this point of a let up in this rising trend.

Chart 1

Resource based sectors in general are underperforming

Most of the charts we will be using today contain the weekly price, the absolute long-term KST, the weekly relative line and the long-term KST of that relative performance. Chart 2 features the materials sector in that format. Here we can see that the price has broken down from its 2016-18 top, having been preceded by a long-term KST sell signal earlier in the year. Relative performance has been even weaker, as the RS line is now back to where it started in early 2016. The red dashed arrows indicate the pervasive weak RS performance that preceded the 2015 top. That sort of vulnerability also happened this year, as the price moved sideways against a persistent decline in the RS line. Usually these kind of RS divergences are followed by an absolute price decline far greater than has already taken place.

Chart 2

Mining and metals, Chart 3, have not yet broken down on either an absolute or relative basis, but both are below their respective 65-week EMA’s and are experiencing bearish long-term KSTs, which makes this ETF look vulnerable.

Chart 3

Not all earnings driven sectors are performing badly. In that respect, Chart 4 indicates that the SPDR Energy ETF, the XLE, is breaking out from a large base and its RS line is edging through a 4-year down trend line. Since both KSTs are in a positive mode, more decisive breakouts appear likely.

Chart 4

Technology also has lagging tendencies, like resource-based stocks. It has been the star performing sector during the course of the bull market, but that may be coming to a close. The price itself remains in an uptrend, above both its EMA and 2016-18 bull trend line. The long-term KST is also bullish, but has started to flatten. That means that a drop that can hold below the red trend line would probably result in a momentum sell signal. Its  biggest problem, lies in the fact that the RS line has violated its red up trend line, an event which followed its 2018 negative divergence with the price.

Chart 5

Defensive sectors are generally improving

A star performer in the defensive area has been healthcare, as plotted in Chart 6. It remains in an uptrend on both an absolute and relative basis. The latter has just emerged from a 3-year base and the relative KST has only just gone bullish. There should be plenty of potential for future upside leadership here.

Chart 6

One area that is trying to emerge, is the utility sector in Chart 7. It’s important to note that these interest sensitive equities have been rallying, in spite of rising rates. Perhaps they are hinting that rates may be headed lower, not higher, as is widely expected. This week, both the price of the XLU and its RS are trying to break above their respective 2018 resistance trend lines. So far, both KSTs remain below their MA’s. However, if the XLU can rally in a plus 3% 10-year yield environment that probably means it is in great technical shape.

Chart 7

Consumer cyclicals were one of the best performers between late 2017 and late this summer. However, the uptrends in both price and relative action have been severely ruptured. Having said that, both series remain above their respective 65-week EMA’s and their KSTs continue to point north. It’s possible therefore, that these downside breaks represent a temporary pause in an on-going uptrend; only time will tell.

Chart 8

Consumer staples (goods) have been underperforming since 2016, as we can see from Chart 9, featuring the iShares Dow Jones Consumer Goods ETF, the IYK. We see no signs of strength that could soon lead to upside breakouts, but if technology is finally vulnerable, the relative action of staples could be about to improve.

Chart 9

Ratio between a late and early performing sector is at a critical juncture

That leads us to our final chart, which displays the ratio between the more speculative XLK with the defensive SPDR Consumer Staples ETF, the XLP. The XLP is the SPDR equivalent of the IYK, shown in the previous chart. Generally speaking, when the ratio is rising it indicates investors are growing in confidence. That’s because they are willing to bid up the more risky technology over the higher yielding, but relatively safe consumer staples. You can see a rough correlation between swings in the S&P and ratio. As at Tuesday’s close, it was resting on its 2016-18 bull market trend line with a weakening short-term KST. If it violates the line to any great degree, that would suggest a reversal in roles, whereby consumer staples had begun a period of superior performance against technology. Such action would also hint that the S&P itself could be about to test that critical support at which both trend lines are currently converging.

Chart 10

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.