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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.
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LEADERS: DEFENSIVENESS CONTINUES
Financials (XLF) – The Next Few Weeks
Comments: Financials have held up fairly well throughout recent global market volatility, but the sector still appears to be rolling over. Financials tend to outperform when the yield curve steepens, and underperform when it flattens. The fact that a sharp steepening has occurred in the absence of a meaningful period of renewed leadership in the sector might mean the market is preparing for flattening to come.
Health Care (XLV) – Still Up
Comments: Health care had gone vertical in terms of dramatic outperformance, peaking around the same time as consumer staples, and has since held up fairly well as other defensive sectors cratered. Leadership thus far looks to be holding, consistent with some defensive rotation underway.
Small-Caps (SLY) – Intact
Comments: Small-caps have performed nicely throughout recent market volatility, outperforming multinational large-caps as leadership remains intact. Much of this may be due to concerns that global growth is not robust, which negatively impacts global large-caps relative to more domestic small-caps.
LAGGARDS: NO OOMPH
Technology (XLK) – Broken
Comments: Technology appeared ready to lead again but recent weakness has kicked in, causing the sector to roll over. I am not convinced severe underperformance is about to follow, but clearly momentum does not favor near-term leadership, which is likely due to global volatility and growth concerns.
Emerging Markets (GMM) – STILL OVERSOLD
Comments: There was a brief moment where emerging markets seemed likely to lead, but QE-tapering talk combined with volatility in Japan has caused severe underperformance. We are now reaching incredibly oversold levels, with the MSCI Emerging Markets index underperforming by over 2500 basis points relative to the S&P 500 (^INX) I maintain that a major trade is coming, but momentum needs to aggressively turn first. Concerns in China may be priced in, and negativity all around for emerging markets may be a contrarian sign.
Treasury Inflation Protected Securities (IPE) – Wowzers
Comments: The IPE/TENZ price ratio is one way of seeing if inflation expectations are rising or falling within the bond market. When the ratio is trending higher, it means bets are occurring on rising prices ahead. Note that the ratio has been falling, indicative not of inflation but rather deflation concerns. The trend is still down, and would need to reverse for the cyclical trade to be longer lasting.
From an intermarket trend standpoint, not much has changed except for continued weakness and deflationary concerns within the market. QE tapering seems to be heightening concerns, which in turn could mean more volatility combined with lower stock prices are ahead. My firm's ATAC (Accelerated Time and Capital) models used for managing our mutual fund and separate accounts still favor bonds over stocks, and July might prove to be a countertrend month for fixed income.
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.
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