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Monthly Archives: January 2012
One Sign of a Bull Market
The strongest bull markets occur when there is a perpetual bid beneath the market. When buyers are aggressive, any bout of selling that seizes the market dissipates quickly. The depth of the retracement, then, can often reveal the underlying health of the trend. Consider the following two trend descriptions:
Stock ABC runs $10 higher, drops $3, runs another $8, drops $2, runs another $9, and drops $2.50 before running another $10 higher.
Stock XYZ runs $10 higher, drops $7, runs another $10, drops $8, runs another $9, and drops $6 before running another $8 higher.
Although both stocks are forming higher pivot highs and higher pivot lows, stock ABC is decisively stronger. Buyers are relentless as they’re only allowing the stock to retrace a small amount before jumping in and bidding the price higher yet again.
Source: MachTrader
An assessment of the S&P 500 Index over the past month reveals a similarly strong market. As shown in the hourly chart above, every dip has been both shallow and short-lived. Although we awoke Monday morning to a notable gap down, it become yet another in a long line of selloffs that were bought up.
How long the strength in the market will last is anybody’s guess. However, provided the selling pressure remains as tame as it has in recent weeks, traders should give the market the benefit of the doubt we see higher prices.
Wikipedia: benign definition: of a gentle disposition. →
Sector Rotation
2012 has kicked off in quite the bullish fashion. Here we are a mere three weeks into the New Year and the Nasdaq Composite ($COMPQ) is already up a quick 7%. What’s perhaps more interesting is the stark difference between market conditions during the back half of last year versus what we’ve witnessed over the past month. The incessant volatility of last fall has faded into the background as a new, more docile market has taken hold. While the bulls could point out a number of data points lending support to the relatively nascent uptrend, one phenomenon which has shifted strongly in favor of the bulls is sector rotation.
The essence of sector rotation theory is as follows: Money flows through different market sectors over time as the economic and market landscapes shift. During recessionary periods when the equities market is susceptible to severe corrections, defensive sectors like utilities, consumer staples, and healthcare tend to outperform. Conversely, during times of economic expansion aggressive sectors like technology, industrials, and basic materials tend to outperform.
The following model, linked to in our MachTrader software, provides an enlightening overview of sector rotation theory:
In looking at sector performance during 2011, one overriding theme becomes apparent – defensive sectors were the out-and-out leaders (see graphic below). Not exactly the type of leadership you want to see if you’re seeking a bull market.
Fortunately, 2012 has seen notable rotation into more offensive sectors (see graphic below). The worst performing sectors so far this year have been the exact sectors which performed best last year. Consider this change in character at least one sign that risk appetite is on the rise. If this new theme of offensive sector leadership persists, the bulls should continue to have the wind at their back.
