02/05/14   Time To Switch To Defense?

Editor’s Corner

Ron Rowland

When the market is plagued by uncertainty, various defensive groups often display superior relative strength characteristics.  Usually, this reveals itself in these sectors falling less than the broader market.  Over the past week, Utilities decided to erase that generality and not only outperformed during a down market run but managed to post a gain.  Health Care was not able to buck the negative signs, but it did keep its losses much smaller than the broader market.  This was not out of character for Health Care, as it has been on a strong and steady climb for over a year.  The third member of the defensive group, Consumer Staples, has been struggling.  It didn’t follow suit and instead posted the largest drop of any sector the past week.  Due to this vast discrepancy in performance, we are not ready to jump on the defensive bandwagon just yet, but the trend bears watching to see how it develops.

Some of the current market uncertainty is being created by economic reports.  The ISM manufacturing index fell over five points to 51.2 in January when analysts expected a drop to only 56.  With the index remaining above 50, it still indicates growth but not by much.  While consumer spending increased in December, the University of Michigan consumer sentiment index fell to 81.2 in January from 82.5 a month earlier.  As earnings season comes to a close, nearly 80% of reporting companies beat analysts’ expectations, but there were big names such as Amazon (AMZN) and Mattel (MAT) that missed.  Right now, it seems both bulls and bears can find data to support their bias.

Today, ADP released its monthly private sector employment report and claims 175,000 jobs were created in January.  Although that is not far off from expectations, it is the lowest number since August.  While 175,000 jobs may be about enough to keep up with population growth, it won’t do anything to help increase the percent of the population that is working.  We will get the government numbers on Friday.

Not much good could be said for bonds in 2013, but they are making productive use of the clean slate they were handed on January 1.  The U.S. aggregate bond market added about 1.5% in January.  Other commonly followed measures performed even better.  Inflation protected bonds headed up about 2% as reflected by iShares TIPS Bond (TIP).  Medium-term treasuries, iShares 7-10 Year Treasury Bond (IEF), were lifted about 3%.  As you move toward longer durations, the month looked even better as Vanguard Extended Duration Treasury (EDV) surged nearly 10%.

Investor Heat Map 2/5/14


The list of sectors in upward trends continues to shrink.  Today we are down to just four as three more moved into negative territory.  Health Care is still on top, although it has weakened since our last update.  Biotech has been the strongest industry within the Health Care sector so far this year but now appears to be falling as quickly as it rose.  Utilities climbed two more spots to second place after springing up five spots the prior week.  Utilities perhaps came too far too fast and has given back much of its recent gains the past few days.  Real Estate moved from fifth to third and managed to post gains over the past week.  However, Real Estate has been unsuccessful in its attempts to maintain an upward trend the past eight months, so we would approach this area of the equity market with caution.  The improvements in Utilities and Real Estate pushed Technology down from second to fourth place, and it is on the threshold of flipping over to a negative trend.  Industrials, Financials, and Telecom are the three sectors moving into the red today.  Industrials is holding up better than the other two and could provide upside leadership again if the market is able to rally from here.  Last week’s lowest ranked sectors all moved deeper into the red.  Consumer Staples now claims the last place position, which is completely out of character for a defensive sector.


Micro Cap finally succumbed to the recent market weakness, and it is barely hanging on to the last shreds of its upward trend.  The ten other style categories all flipped from positive to negative today.  This many categories changing direction in one week is a rare occurrence.  There are some notable relative strength shifts in addition to the massive color change on the chart.  The three Mid Cap categories moved up three places in lockstep to capture the upper area except for the top spot controlled by Micro Cap.  This area was previously the purview of the Small Cap categories, but they are now scattered across the rankings with Small Cap Value sitting on the bottom.


Four global categories remained in positive trends a week ago, but today they can no longer make that claim.  The U.S. climbed two spots to take over the lead from a relative strength standpoint.  However, since all regions are in a negative trend, the best we can say is that it is “least worst” of the bunch.  Europe and the U.K. each slid down to allow the U.S. to take the top spot away from Europe.  EAFE was the least strong of the four categories at the top last week and dropped two places to sixth today.  This allowed World Equity and Canada to move up the list despite the fact they both lost value.  Japan had a terrible week with the Nikkei plunging 4.2% on Tuesday and nearly 9% over a four-day stretch.  As a result, Japan moved lower in the rankings with only the three developing market categories below.  Emerging Markets, China, and Latin America all moved deeper into the red.


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“There’s uncertainty around the economic outlook. People had a lot of confidence coming into this year that the economy was accelerating, and the recent set of economic statistics have thrown that into question.”

Walter Todd, Chief Investment Officer of Greenwood Capital Associates, 2/5/14


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