When applying Relative Strength analysis to your investment decisions it is always a good idea to keep a close eye on which industry groups are leading and lagging. The primary method for using Relative Strength investing techniques starts with picking stocks from the strongest groups. You assess which groups are acting the best and then you find the individual names within those winning sectors. A common way to analyze your sector strength/weakness is to look at how each group has performed, relative, over the last year. Fortunately we find ourselves at the beginning of a new year and now would be the perfect time to look back on 2013 and see how each group performed relative to the broad market averages. Determining which groups are leading and which are lagging will give us a clear picture to begin forming our plans for 2014.
Lets take a look!
We will be looking at Daily 1-year charts. The SP500 relative comparison will be shown as a % overlay on each sector's chart (the SP500 YTD return is the pink line). If the price is above the SP500 pink line it means the sector outperformed the broad market; if price is below, the sector lagged vs the market.
Consumer Discretionary (XLY) +41%
The best performing S&P Sector for 2013 was Consumer Discretionary. Up a stellar 41%, it lead the markets higher all year. A very good sign for a recovering economy is to see discretionary companies posting record profits; this is what we saw in 2013. With this sector performing so strongly last year, I expect it to continue to lead into 2014 and will also be a strong indicator for when this rally may be coming to an end.
Health Care (XLV) +39%
Health Care had a very strong year in what I believe is a continuation of a trend that could continue for many more to come. The Baby-Boomers aren't getting any younger and therefore will have even more dependence on health insurance, pharmaceuticals, and medical devices. If I had to pick one investment group to bet on for the next 30+ years, it would be through healthcare companies. We don't currently have a Health Care stock for our top 10 list, but I have my eye on several that might make an appearance.
For those who would like to check out a few names, i particularly like Abbott Labs (ABT), United Health Care (UNH), a few of the big bio-tech GILD, AMGN, CELG...There are a lot of things to like about all these companies going forward and if you have a longer time horizon on your investments, I recommend you take a look at the space.
Industrials (XLI) +38%
The Industrials have been the major market leader over the past couple months and should be set up to continue leading higher into 2014. After trading more or less in lockstep with the SP500 for the better part of the first 8 months, Industrials broke higher and haven't looked back. We do have a new support base to move up our trailing stops. With the recent sideways consolidation from November to the end of December, we can move up our invalidation point to $49, just under those support lows.
Financials (XLF) +33%
Financials are set up to push the markets higher as we enter 2014. The first couple trading days of the new year have been generally rocky, but not for the XLF. Many banking stocks and insurance companies are trading at fresh 52-week highs and some at new all-time highs (WFC for example) at the close today and look as though the next leg higher has begun. When the Financials lead, the markets always perform well.
Technology (XLK) +24%
Now we come to the groups who have struggled more than some this year. While a 24% return is nothing to scoff at, Technology has lagged the broader averages all year. Only recently has it begun to play some catch up. Its not there yet but I am hopeful that the XLK can overtake the SP500 soon and add more fuel to the continued bull market.
Energy (XLE) +24
Energy has not been an easy trade for us all year. It has constantly been tantalizing as a breakout candidate, yet then it fades. We have seen multiple attempts this year and it just hasn't been able to rotate into a leading group. While the current price action suggests more upside to come, it does still seem that this could struggle to really take off early in the year.
Consumer Staples (XLP) +23
Staples have been a weird group in 2013. While they closed the year with a respectable 23% gain, they have caused a lot of confusion for investors. When the market was in full rally mode from January through May, the Staples were one of the leading groups. After taking a pause over the summer the SP500 has managed to distance itself from the XLP and looks like another positive phase could be coming to risk assets.
I use the Staples sector as a good judge of investor appetite for risk. When the market is nervous after a big move, investors will position themselves into Staples for safety, yet still wanting to participate in the upside in some way. Typically it has been bad for the markets near term future when Staples lead and it is typically good when the Staples lag. We look to be at a point where the market wants to leave the more risk adverse in the dust and motors right ahead with the XLP trying to play catch-up.
Because of the recent lagging behavior in the XLP, I will be using the low at $41.69 as our tight stop.
Materials (XLB) +23
Similar to the other more choppy groups on our list, Materials is having a hard time putting together any sustained rallies. While the most recent action over the past couple weeks has certainly been strong, I want to see some continued out performance over the next couple months. I think a near term pullback could be in order, but I hope we can see some real buying come into this group soon.
Utilities (XLU) +9%
Now we come to the really nasty ones from 2013. Utilities hardly did anything this year finishing up 9% and severely lagging the SP500. Now I shouldn't say they didn't do anything, because nearly 10% capital return from the Utility sector is actually pretty darn skippy, especially when you consider the almost 4% annual dividend the XLU pays out as well. But that's not what we do here; we don't put our heads in the sand and hope Utilities have a good year. We assess sector strength and rotation and we allocate toward the leaders. While Utilities present an intriguing value and easy risk/reward, we trade on strength, momentum and breakouts...Those things have certainly been lacking this year for the XLU.
20+ Treasury Bond (TLT) -15%
If you invested heavily in Bonds this year in fear of a market crash, you got hit pretty good. 20+ Year Treasury Bonds traded lower by 15% in 2013. If you invested in the TLT this year, not only did you lose 15% on whatever you allocated toward Treasuries, but you also lost the opportunity cost of being invested in one of the best years for equities. So you lost 15% on bonds and missed the other +30% from stocks...This is why we use charts and Relative Strength, to avoid these troubling situations. There will come a time when Treasuries are a
great buy but that time is not now and not likely in 2014 from the look of this chart.
Gold (GLD) -28%
And rounding out our 2013 list is the investment that should never go down. Gold will save you when the end of the world comes...or something like that. One of the best quotes I read this year was from Barry Ritholtz, "the end-of-the-world trade has been a sucker's bet since the beginning of time". I just love that! I'm an optimistic kind of guy and I don't want to have to dig out bunkers and barter with gold bricks. I like to think that things are improving and that the United States will be more or less the same for my kids as it was for me.
That's not what the gold bugs and "Cash for Gold" people will tell you. They think we are doomed and the only way to protect yourself will be with guns and gold. Well, my question is then, why isn't the price of gold factoring in the dooms day scenario? Since they all seem to think this is imminent, why has gold lost 30% of its value this year? If the world would be ending, you would think there would be a little more demand for the shiny stuff. My best guess is because the world is not likely to end any time soon and the use for gold is simply a defense against the unthinkable occurring.
Which brings us to the chart. That's one nice downtrend! If the markets were ready to substantially correct, we should see gold take off and breakout from its intermediate term downtrend. Until that happens we need to stay sidelined or short gold (as we currently are).
In my current view, it is probably best to think of Gold as insurance and not as an investment class. It likely couldn't hurt to have some hidden somewhere, but as a major allotment of your portfolio, it likely should not be.
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When trading with Relative Strength the idea is to be Long the strongest groups and Short the weakest groups. We have been quite consistent with this plan throughout 2013 and it has worked well. Our Portfolio is currently Long XLF, XLY, XLI, XLK, XLE, XLB, XLV, and XLP, and we are currently Short Gold. We also have no position in XLU or TLT and we have not in 2013. We have managed to stay aggressive the strongest groups and avoided the weakest ones.
Those who say you can't time the market are not understanding the concept of what we are trying to do here. Timing the market (to me at least) does not mean picking the exact tops and bottoms. To me timing the market has more to do with identifying trends and strength, and positioning our self in sympathy with those groups. We're not attempting to call the top or pick the bottom tick. All we want to do is find the leading stocks in the market and jump on for the ride. That is timing the market; being able to target a certain positive expectancy scenario and expose yourself to the higher likely outcome. As you can tell from following me this year, we have been able to do quite well while keeping our risk very minimal. The buy-and-hold folks have done well this year too, but they risk 100% of their accounts 100% of the time for an average annual return of 8%. They use no stops, no risk management and have to deal with inevitable market corrections at full exposure. By controlling our risk we are able to maintain a very aggressive allocation when times are good and still keep very controlled risk parameters to our accounts at all times. If things turn negative we shift our allocations to where the strength is and away from the weakness. We haven't seeing it in 2013, but there will come a time (lots of them in fact) where our current leading stocks will be the dregs leading the markets lower and we will need to adjust. Now however is not a time to adjust.
So lets just continue to do what we do heading into 2014. There will be a ton of talk and prediction about what to expect in 2014, but we simply need to treat the next 12 months exactly like he have the previous 12. We will watch for trend shifts, leadership changes and high expectancy outcomes. We will align ourselves with the dominant trends and assess risk carefully on every position we enter. As of the close on January 3rd, our Portfolio is aggressively positioned and currently 85% invested.
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