Tuesday, October 23, 2018

Defensive and Value leadership = Bear market?

Mid-week market update: I am publishing my mid-week market update early in light of the recent market volatility.

I use the Relative Rotation Graphs, or RRG charts, as the primary tool for the analysis of sector and style leadership. As an explanation, RRG charts are a way of depicting the changes in leadership in different groups, such as sectors, countries or regions, or market factors. The charts are organized into four quadrants. The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotates to lagging groups (bottom left), which changes to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again.

RRG analysis through a style, or factor, lens. Growth styles have been weak and they are located in the bottom half of the chart. By contrast, value styles such as dividend growth, high quality, large cap value are ascendant.

The RRG chart through a sector rotation lens tells a similar story. High beta sectors, such as technology, communication services, and consumer discretionary stocks are in the bottom half, indicating weakness. By contrast, defensive sectors such as healthcare, utilities and consumer staples are strong.

This kind of market action can be interpreted in two ways. On one hand, it is not unusual to see defensive sectors become the sector leaders during a market pullback. Once the bulls regain their footing, the high beta sectors can regain their footing and lead the market upwards again. On the other hand, the emergence of defensive and value leadership can be a signal of a regime shift where the bears are slowly taking control of the tape.

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