Tuesday, May 6, 2014

A market correction trigger?

In a recent post, I wrote that I was watching the relative performance of cyclical stocks against the market for rising expectations that economic growth was about to accelerate (see The bearish verdict from market cycle analysis). I stated that cyclical stocks looked a little wobbly but the relative uptrend was (sort of) still intact. Under those circumstances, the reasonable thing to do is to give the bull case the benefit of the doubt.

After the close on Tuesday, I reviewed the chart of the relative performance of the Morgan Stanley Cyclical Index (CYC) against the SPX and found that CYC had broken down out of its relative uptrend that stretches back almost two years (solid line). Any way you look at it, it had also broken down out of a short-term relative uptrend (dotted line).

Recently, Business Insider highlighted analysis from Citi credit analyst Matt King showing the negative divergence between stock prices and estimate revisions, or the momentum of changes in fundamentals.

Sometimes these kinds of disconnects have a way of not mattering to the market until it matters. Could the technical relative breakdown in cyclical stocks that it's starting to matter? If so, could such a change in market psychology be one of the triggers for a market correction?

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.


Anonymous said...

Do you think the correction will be confined within the momos/growth stocks, while the values move higher, keeping the overall averages near unchange? Or do you think the weakness will eventually spread throughout the broader market?

dvp said...

Equities appear to be rising based on perceived value (relative to bond yields), corporate buy backs, expanding PE and M&A activity, despite negative earnings. The 10 year yields circa 2000-02 was in the 5% range, in 2008 around 4% and the federal reserve had a much smaller balance sheet. Now, the conditions are different with 10 year yields close to those in 2009, with an implicit guarantee of another round of money printing that may be behind the rise in the S&P despite the negative pre-aanouncemts. That said, we could well be looking at a market peak, give or take 5%. You have shown ample evidence to a peak in the market.