I got some push-back from readers after my last post, Ursa Major or Ursa Minor. The gist of the objection was that stock market leadership can rotate and a commodity price sell-off is not necessarily a precursor to a bear market. Stocks can continue to rise because of the stimulative effects of lower oil and other commodity prices.
I beg to differ.
Many secondary indicators of risk appetite and cyclicality are rolling over. The weight of the evidence suggests that the bears are now in control of the stock market. Consider, for example, the ratio of relative performance of the Consumer Discretionary sector (XLY) to Consumer Staples (XLP), my favorite measure of risk appetite. This ratio topped out in February and has been in a relative downtrend ever since, indicating that risk appetite is in retreat.
The market rally from the March 2009 bottom has driven by the expectations of a cyclical rebound. The accompanying chart of the Morgan Stanley Cyclical Index against the market shows a similar pattern of broken relative uptrends. Can the equity market continue to advance when cyclicals are going sideways relative to the market?
Also consider where market leadership is coming from: defensive sectors such as Consumer Staples. Is this the sign of a healthy bull?
Other defensive sectors, such as Utilities, are also leading the market.
Mark Hulbert pointed out that Ned Davis Research concluded that their studies of market sector rotation is pointing to a market top. I concur with that assessment.
The bigger question is whether this is just a minor pullback or the start of something bigger. For that answer we will have to watch and wait.
Macro and Credit - Outflow boundary
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