After posting new multi-year highs in mid-September, most markets are now drifting. However, that drift is hard to define because nearly every segment seems intent on adding its own flair. If major market benchmarks define the average, then it’s probably safe to say the majority of stocks are drifting slowly downward. Energy, retailers, and developed international markets are all good examples of this trend. Not all groups are falling in line with the averages though. Sideways is the preferred drifting direction for gold, telecom, and many emerging and frontier markets. Upward drifting is evident among health care stocks, emerging market bonds, and MLPs. Traders have been complaining about the ever increasing correlations for stocks and other asset classes the past few years. Perhaps we are seeing early signs of a reversal and correlation levels will begin to drift lower.
Many factors can produce varying results across different market segments, essentially creating winners and losers instead of just positive or negative market reactions. As the fourth quarter gets underway, there are many upcoming events with the potential to push various market segments in different directions. The most obvious one is earnings season. As always, there will be some upside surprises as well as some negative ones. Sometimes, the unexpected results are fairly random, but more often than not, upside surprises are clustered in similar industries and sectors. The same can be said for downside surprises. When either the quantity or magnitude of these surprises becomes large enough, stock groups start behaving more independent of each other instead of moving up and down in unison.
In case you haven’t heard, 2012 is an election year, and we are coming into the final stretch. The Presidential debates begin this evening with campaign rhetoric shifting into high gear. The markets always contain some level of political risk, but that risk will intensify greatly over the coming weeks. As the “likely outcome” shifts with each new speech and endless parade of polls, the various sectors thought to be the winners and losers will change as well.
Of course, the fourth quarter will have plenty of macro events that will appear to affect all stocks the same. This week’s employment report is one such item, as is the ongoing saga known as the European financial crisis. The fiscal cliff also fits into this category and hasn’t been resolved either. Depending on the outcome to all the unknowns above, markets could post breathless rallies, heart-stopping plunges, or both. Enjoy the current calm drifts while you can.
Telecommunications remains on top of our Sector rankings this week, sporting the best momentum score across all 32 equity categories. Its lead over second place Health Care has diminished substantially. Health Care avoided much of the market consolidation activities the past two weeks, closing at a new life-time high yesterday. Energy had a rough week, although it somehow managed to climb a notch to regain third place. Consumer Discretionary traded places with Energy, landing in fourth place this week.
The lower half of the Sector rankings looks much the same as in our last update. The most noticeable change is in the tighter compression of momentum scores. Materials and Financials held their positions, effectively halting their slides of previous weeks. Consumer Staples and Technology swapped places, with Technology falling lower this week. Industrials and Utilities complete the lineup. Once again, Utilities is the only sector registering a negative trend.
Extremism prevails in the Style rankings. Micro Cap, the smallest of the small, held on to its top spot after making a rapid ascent through the rankings in September. The second place spot is now held by the other extreme – Mega Cap stocks. With the very small and the very large leading the market, you might expect the mid-sized companies to be lagging. Well, you would be correct. The three Mid Cap categories are indeed at the bottom of the Style rankings, and all three are sitting there with identical momentum readings.
Small Caps and Large Caps of the non-extreme variety occupy the middle ground. Their relative rankings are somewhat jumbled, and the tight compression suggests a new alignment could form quickly. For now, Small Caps have a slight edge over Large Caps, but the strength of Value over Growth appears to be the more important factor.
Europe has had its head well above the crowd for many weeks now. It resides on top again today, although its huge lead over all the other categories has evaporated. Last week, we suggested that short-term weakness in oil prices and the Canadian dollar could push Canada far down the list. Canada proved us wrong and even strengthened its hold on second place as other categories encountered greater weakness. Pacific ex-Japan jumped two places to third. Even though the Materials sector is not gaining strength, the resource-rich categories of Canada and Pacific ex-Japan are improving their relative positioning. Emerging Markets jumped from 8th to 4th, primarily on strength in China. The next four slots are occupied by EAFE, UK, US, and World Equity. The US has been drifting down the list, this week landing in seventh place.
The most notable changes to the Global rankings are taking place at the bottom. China turned in the best one-week performance of any equity category, allowing it to climb out of last place. Stock prices there are trying to stabilize despite increasingly negative sentiment regarding the Chinese economy. Latin America could not follow through on its early September advance and remains stuck near the bottom of the rankings. Japan now occupies the bottom slot and is the only Global category with a negative trend.
“To reach a port, we must sail – sail, not tie at anchor – sail, not drift.”
Franklin D. Roosevelt
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