Sunday, December 7, 2008

Sector Rotation?

“The market doesn’t build rallies on toilet paper.”

Sure, the more jaded and cynical will make funny comments about the Fed monetizing the ever-expanding deficit in the future. And the very darkest souls might even make references to burning money to stay warm a la Weimar days. But I still think that statement stands on merits – consumer staples is the sector that money gets parked in when it has no better places to go. And when consumer staples, healthcare and utilities are the best performing sectors, the broad market isn’t really going to go anywhere in an economy that is still 70% dependent on consumer spending.

Here’s a chart from Yahoo! showing the various sector SPDR ETF relative performances over the past year-to-date:

SPY has been abysmal and XLP (Cons. Staples) has been the best relative performer followed by XLV (healthcare) and XLU (utilities) – generally not the sectors one would expect to lead a SPY rally.

However, in the last week the better performing sectors have been the year’s most beaten down – XLF (financials) and XLY (cons. discretionary). The collapse of energy has been one of the big reasons that SPY has not advanced further. Energy (XLE) and commodities (XLB) played a massive role in the SPY advance after the tech-bubble collapse – perhaps even more so than the financial sector. This chart link shows that pretty clearly: SPDR 1998-Present.

To go one step further, since August when the week's leading sector was XLF, XLY or XLK (tech) the average return on SPY was 0.33%. While that's not great, SPY has shed -30.3% in the same period. Further, when a defensive sector like XLP, XLV, or XLU has been the week's best performing, SPY has returned an average of -6.87%.

This is all well and good, but it is backwards looking. XLF and XLY have both pulled off of their lows and the 30 DMAs that had marked strong resistance areas in the past couple months has been breached in the case of XLY and being challenged in the case of XLF - both encouraging signs. Particularly so since SPY itself seems to have formed something resembling a bottom and the 30 DMA in that case has almost no room left to fall from a math perspective barring a massive blowout of the 800 level pretty soon.

In the coming week, there are no earnings releases of great note (see previous post) and the macro releases are generally of the variety that are ignored until Friday morning when the retail numbers for Novemeber are released. I am of the opinion that home sales numbers are kind of like GM in the Dow - they've been so bad, so long that they can no longer do any significant damage. The initial claims number coming up has some noise in it and the last few week's have been bad enough that it would seem very possible that an incremental improvement appears. However, even if it doesn't the last unemployment figures were horrific and essentially ignored by the market anyway so there's no reason to think this one won't be as well. Friday makes me nervous though since it will contain the first couple of holiday shopping days.