Part of my investing strategy is to buy the strongest performing stocks over a given time-frame. If I'm taking a shorter trade I will only look back a couple months to determine relative strength. For longer, investment type purchases, I like to look much further back and find the long term out performers. Relative Strength is the concept of tracking a certain asset's performance compared to the SP500 or any other stock or index. If you just buy stocks or mutual funds without first comparing it to the overall market performance you may be putting you money in the wrong place for best results. If a stock is under performing compared to the SP500 then why take any time at doing research at all? You would be much better off just buying the SP500 fund and leaving it alone. But that is not the purpose of what we are trying to do here, we are trying to beat the market, we are looking for superior returns. In that case we need to be owning assets that are performing better than the SP500, and should be paying close attention to each group's relative strength.
The SP500 sector groups are broken into 9 primary groups:
Offensive Groups
Financials- XLF
Consumer Discretionary- XLY
Technology- XLK
Industrials- XLI
Basic Materials- XLB
Energy- XLE
Defensive Groups
Consumer Staples- XLP
Healthcare- XLV
Utilities- XLU
Bonds
Gold
US$
Bonds, Gold, and the US Dollar are not SP500 sectors, but I like to look at them as well to get an idea of investor's risk appetite.
Typically the offensive sectors are the more economically sensitive groups. So when market conditions are the strongest, those are the groups that should be performing the best. The defensive groups tend to see money flow into them when conditions become more risk adverse and these are thought of as "safe haven" holdings. You see, big funds cannot sit in cash for long periods of time. They are required to put money to work for their investors, and therefore we tend to see their money rotate from group to group as conditions and valuations change. As you can guess, its pretty important to know where money is shifting within the markets at any given time because that is what makes prices move up and down.
All that being said, lets take a look into the SP500 groups to see where we stand at these near historic market levels.
Financials- XLF
The Financials look strong here. They are riding a very strong price trend and have been consistently out performing the SP500 for a year now. Any weakness at this point has to be considered a buying opportunity until the lower trend and rising 50 DMA is broken. This is bullish for the market.
Consumer Discretionary- XLY
The Discretionary space looks very similar to the Financials right here. Strong price trend and strong relative strength; continue to buy dips in this space as long as these two factors are in play.
Technology- XLK
Technology has been a very disappointing space for investors for this entire 4 month rally as it has consistently under performed for over 6 months now. This is primarily linked to the horrible performance of AAPL which has dragged the whole sector down. Until we see money start to flow into tech, its better to stay away. The first thing we will be looking for here is for the relative strength line to break above the downtrend resistance. That will be a signal that a shift is underway.
Industrials- XLI
Industrials have performed well over the past 4 months, but now have seemed to have slowed. With concerns over China's growth coming back to the forefront, the industrial space has started to break its out performance uptrend. Typically when the relative strength trend breaks its no bueno.
Basic Materials- XLB
Materials have been disappointing during most of this rally and have been showing clear under performance as a group since mid-January. Until this starts acting better you would be wise to look elsewhere.
Energy- XLE
Energy looks a lot like Materials. I think there are better prospects in the market right now.
Consumer Staples- XLP
While it seems that consumer staples have been ripping, they haven't really been doing so on a relative basis. The staples are now testing upper resistance on its relative strength chart and this could help clarify in the coming weeks whether staples will make a new relative high or continue to trade in the range.
Healthcare- XLV
Healthcare has been a top performer during this current rally and has a very strong trend vs the SPY, which has recently moved to new highs. Price looks to be forming a rising wedge pattern which tends to resolve to the downside, but we will have to see that happen before we get too concerned about healthcare.
Utilities- XLU
Utilities have broken out of a longer term downtrend in relative strength and seem to be seeing a solid rotation of funds. Usually when utilities start to out perform, its bad news for the market as a whole.
20+ Year Treasury Bond- TLT
Treasury bonds have been in a very clean downtrend for about 6 months now and are currently testing the upper resistance boundary in price and relative strength. Treasury bonds as an asset class tend to trade inversely to the market. If both price and relative strength were to break to the upside here that would be a very negative signal for the market.
Gold- GLD
Gold has looked similar to bonds since mid-November and shows the risk appetite for market participants over that period of time. Gold is thought of as a fear trade, people want lots of it when they are scared and want nothing to do with it when they feel safe. Right now GLD is attempting a breakout of the 6 month relative strength trend and seems to be catching a bounce. The key test for gold will be sustaining this bounce and breaking out above the $159 level. I would be a buyer of that move.
US Dollar- DXY0
Yet another safety trade is the US Dollar. When Europe or Emerging Markets get all jittery the Dollar catches a bid. First it was the elections in Italy and now the Cyprus banking issues, the world continues to see the US as the strongest and safest. The Dollar has broken out from its relative strength downtrend and is now sustaining a 2-month upward trend. Typically the S&P performs better as the Dollar moves lower, now the Dollar seems to be taking the lead.
Conclusions:
I'm seeing some things that concern me and others that could be great opportunities. As of right now only 2 offensive sectors are leading (XLF,XLY), and most others seem to be rolling over. Technology could be interesting if it breaks out. There are many big investment managers that won't believe in a major rally unless technology is leading the move higher. Tech has lagged badly for this entire rally and it is possible that if technology breaks out it could be the next catalyst for the breakout to new market highs. AAPL would be VERY interesting for a short-term trade if that were to be the case.
What concerns me is how almost every defensive group is breaking out or testing a breakout to the upside vs the SP500. All the while, over the past month Industrials, Materials and Energy all seem to be weakening considerably. When momentum starts to swing from prior out performers into the defensive's, its usually a sign of underlying weakening of the current trend.
While I remain 50% invested at the close Friday, I will continue to look for both opportunities to buy and opportunities to sell. I would be a buyer on further weakness in Financials and Discretionary, as well as Technology if it were to breakout here. But at the same time, if the offensives continue to lag while these key defensive plays rally, I will be looking to further reduce my holdings into any market strength we see up to S&P 1,575.
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