Sector Rotation Perspective Update (XLF, XLY, XLK, XLB, XLI, XLE, XLU, XLV, XLP, SPY)

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March 23, 2011 12:07pm NYSE:XLB NYSE:XLE

I’ve been keeping a close eye on the Sector Rotation model and its bullish signals from the September 2010 market low (the onset of QE2 Rumors) and the model has held-up well.

Let’s take a look at two perspectives of recent Sector Performance – one from the February 2011 top and the other – surprise – from the August/September 2010 “QE2″ bottom.

First, the recent sector behavior from the February 2011 market top:

ETFs:  Financial Select Sector SPDR (NYSE:XLF), Consumer Discretionary Select Sector SPDR Fund (NYSE:XLY), Technology Select Sector SPDR Fund (NYSE:XLK), Materials Select Sector SPDR Fund (NYSE:XLB), Industrial Select Sector SPDR Fund (NYSE:XLI), Energy Select Sector SPDR Fund (NYSE:XLE), Utilities Select Sector SPDR Fund (NYSE:XLU), Health Care Select Sector SPDR Fund (NYSE:XLV), Consumer Staples Select Sector SPDR Fund (NYSE:XLP), SPDR S&P 500 ETF (NYSE:SPY).

What we’re seeing is the typical performance according to the model during a bearish retracement period in the broader market.

How so?

The “Offensive” (aggressive/bullish) sectors like Financials, Technology, Materials/Industrials and Discretionary/Retail are all the WORST performing sectors – with the high-beta Technology Sector (NYSE:XLK) leading the decline – down 5.5%.

The Defensive (safe/bearish) sectors like Staples, Health Care, and Utilities have outperformed both the S&P 500 (down 2.5%) and other sectors as investors took more defensive postures.

The one exception/outlier is not surprising given our current environment, in that Oil/Energy was the top performer – up 3% – in the context of a broader market pullback in the S&P 500.

That’s not surprising if we factor in the conflicts in the Middle East along with the QE2 inflation-producing policies of the Fed.

I’ve mentioned in the past that energy/oil stocks would be one of the top benefactors of the inflation created by QE2 – which both boosts stocks and oil… placing leading oil stocks in a position to benefit from the QE2 policies.

That is a topic for another discussion, but for now, the Sector Rotation model is in-line with a bearish pullback in the markets and the sector performance – and outperformance – is in line with expectations.

Now, let’s pull the perspective back and update the current sector performance relative to the August 2010 low:

We see the opposite picture from the pullback scenario, as the image above is the classic picture of market strength – at least shown from the Sector Rotation model.


From the August/September 2010 market bottom – the onset of the ‘rumor’ of QE2 (Jackson Hole – August 27) – to present, the S&P 500 is up 24% with the Offensive Sectors matching or beating the S&P’s performance.

Discretionary/Retail is up 28%; Industrials are up 32%; Materials are up 27.5%; and Technology is up 23.5%.  The outlier is the Financial sector which is up “just” 21.5.”

What’s the key fact that leaps off the chart above?

Oil.  Energy.  As expected via the QE2 liquidity thesis which boosted inflation and helped cause both stock and oil prices to rise – along with a whole host of other commodities including gold, cotton, cocoa, coffee, etc.

Focusing back on Sector Rotation, the XLE Energy ETF us up 53.5% from the September 2010 market bottom – almost doubling the return of the S&P 500.  Part of the boost is also due to the tension/conflict in the Middle East, as a variety of force have boosted oil/energy prices and thus energy stocks.

And as you would expect, the Defensive sectors – though up – are all underperforming the S&P 500 and all other offensive sectors.  Staples rose 13.5%; Health Care rallied 16.5%; and Utilities put in a disappointing – though not unexpected – low return of 4.5%.

As always, the key take-away is that during bull phases of the stock market, certain sectors outperform others and you can add alpha to portfolios/investments by being long the best stocks in the best sectors during a market rise – and it’s not as difficult as you might think to pick-out which groups are expected to outperform.

During bear phases, if aggressive, you can short the weakest stocks in the weakest sectors, or just rotate into a defensive posture depending on how long you expect the bear or retracement phase to last.

Certain sectors are expected to do better (Defensive) in bear phases while others are expected to do worse (Offensive).

Anyway, continue monitoring sector performance in line with the tide of the S&P 500 and take advantage of these over and under-performing sectors – including finding stocks within leading/lagging sectors to trade – as best you can.

Written By Corey Rosenbloom, CMT From Afraid To Trade  

My name is Corey Rosenbloom, CMT (Chartered Market Technician) trader, educator, analyst, and I am excited to share with you my experiences studying and trading the markets and to hear from you regarding your experiences, challenges, and frustrations, and successes. My goal is to create a community dedicated to reaching out to those who have been burned by the market or are anxious about risking their money to make money in the stock, options, or futures markets. Together, we can share strategies and learn how to overcome crippling fears that keep us from achieving our highest potential.

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