The Lead-Lag Report: Corrective Behavior Underway

Michael A. Gayed

If there's not drama and negativity in my life, all my songs will be really wack and boring or something.
-- Eminem

Below is an assessment of the performance of some of the most important sectors and asset classes relative to each other, with an interpretation of what underlying market dynamics may be signaling about the future direction of risk-taking by investors. The below charts are all price ratios which show the underlying trend of the numerator relative to the denominator. A rising price ratio means the numerator is outperforming (up more/down less) the denominator.

For a full version of the Lead-Lag Report, click here.

LEADERS: BEAR TRADE STRENGTHENS

Consumer Staples (XLP) – Aggressive Defensiveness



Comments: Consumer staples have bounced strongly off of a support level and have led in a vertical way since. Leadership seems likely to continue, though a period of weakness could occur for a few days given the strength of the move to begin with.

(More from Minyanville: Where Apple Is Now, and What Levels Are Worth Watching?)

Health Care (XLV) – Breakout Coming?



Comments: Health care has V-ed in what appears to be some defensiveness kicking in within markets as the Dow (^DJI) nears all-time highs. A break above the relative resistance of 0.287 appears to be taking hold. If confirmed with other areas of the market, it would suggest weakness in overall risk markets is likely to continue.

Long Bonds (TENZ) – Yield Curve...Flattening?



Comments: The yield curve appears to be on the verge of narrowing once again, signaling the return of a deflation pulse and risk-off period. Leadership in longer-duration bonds, despite talk of an end to bond buying by the Fed, is important to get a sense of sentiment within fixed income.

LAGGARDS: BETA UNDER FIRE

Financials (XLF) – Over?



Comments: Financials may now be at the start of a turn in leadership given recent volatility in asset markets. With bond yields falling once again and the yield curve beginning to narrow as eurozone fears return, it does seem plausible that underperformance takes hold in the near-term.

(More from Minyanville: Take a Look Inside the New Goldman Sachs Catamaran.)

Small-Caps (SLY) – Broken



Comments: Small-caps have strongly outperformed since late-November in a near-vertical way on the backs of increased domestic growth expectations and bets that the fiscal cliff would get resolved. Recent relative momentum indicates a complete breakdown in leadership has taken hold. This may be due to sequestration concerns impacting the domestic economy, which small-caps are highly sensitive to.

Energy (XLE) – Failure to Launch



Comments: Energy's strength appears to be over as the cyclical trade collapsed, with the ratio unable to definitively break above resistance of 0.52. This for now remains a challenging sector to be bullish on.

Conclusion?

Internal negativity has worsened, as my firm's ATAC (Accelerated Time and Capital) models used for managing our mutual fund and separate accounts remain defensively positioned sensing the return of the deflation pulse. The concerning aspect of this is the earliness of the move, suggesting that declines are far from being over in terms of both magnitude and duration.

Editor's note: This update is published every week exclusively for Minyanville, and is compiled by Michael A. Gayed, CFA, Chief Investment Strategist of Pension Partners, LLC.

Twitter: @pensionpartners

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