Stocks achieved yet another bullish milestone this week with the DJIA notching a new all time high — surpassing the pre-financial crisis high water mark of 14,164.53 set in 2007.
Indeed, stocks are posting robust gains with the Dow up over 8 percent already this year, although many investors have been expecting at least a short-term correction. To be sure investor sentiment is growing more exuberant, although not yet irrationally so, as stocks climb.
And complacency is running high according to the sentiment indicators I follow at a time when there’s still plenty of uncertainty about budget and spending decisions in Washington.
So a short-term pullback would not be surprising, and would even be healthy for markets. Still, the bullish thrust higher over the first two-plus months of this year suggests higher prices ahead in 2013.
|In the face of Washington’s budget battles, stocks seem destined to head higher this year.|
Who’s Leading … Who’s Lagging
That’s why it makes sense to periodically take a closer look at the relative price trends for each major sector of the S&P 500 to help identify which are leading and which are lagging the broad market advance.
Armed with this analysis, you can make a more informed decision about how to tilt your portfolio allocation toward the strongest stocks and sectors, and where you may consider trimming some underperforming positions.
In last week’s Money and Markets column, I examined trading range charts of several S&P sectors to help you pinpoint favorable buy and sell points.
Another way to gain valuable insight into the market, and perhaps an edge in your trading, is to take a closer look at how each sector is performing — not only on a stand-alone basis — but also relative to the overall market as measured by the S&P 500 Index.
Here’s how you can do that …
Take any longer-term daily or weekly chart of an ETF (or any individual stock) and create a ratio by dividing the price history by prices for the SPDR S&P 500 ETF (SPY).
Now you have a uniform and objective way to measure the trend in one security relative to the market index. Most leading chart software providers (including StockCharts.com) should have this feature.
Target Relative Price Breakouts …
Take a look at the Bloomberg graph, above, of the SPDR Select Sector Healthcare ETF (XLV) relative to the S&P 500.
You can see that on an absolute basis, XLV is already trading at new all-time highs (top panel), even though the Dow achieved this distinction only this week, and the S&P 500 Index has yet to surpass its 2007 high. In fact, there’s a strong relative price uptrend in place stretching back to early 2011 (bottom panel).
This shows Healthcare continues to play a leadership role in the market’s advance. And it’s a good bet we’ll see more robust gains ahead from Healthcare. In fact, biotechnology and healthcare equipment stocks are two of the strongest performing industry groups so far this year.
Trends Can Break Down Too …
Now let’s contrast this picture-of-health with the chart below of the Select Sector Materials ETF (XLB)
Basic material stocks were strong last year but have struggled in recent months, in large part due to weakness in gold, silver, and copper prices, which has weighed heavily on mining shares. As a result, XLB remains well below its pre-crisis high. In fact it’s still about 6 percent below its 2011 high.
XLB appeared to break out of a two-year long downtrend relative to the S&P 500 late last year, a promising sign that the tread in materials stocks was turning more bullish. But so far this year there has been no follow through on the upside as XLB has slumped again. Mining and other materials stocks continue to struggle for now.
But another cyclical sector is displaying a much stronger relative price trend and looks poised to break out to new highs: Industrials!
The SPDR Select Sector Industrial ETF (XLI) recently traded above its previous peak set in 2007 and is within striking distance of a new all-time high. And recently, XLI began outperforming the S&P 500 overall, signaling a potential leadership shift in favor of this sector.
Remember: Investing is a relative game. Adding relative price analysis to your investor’s tool-box can help you identify leading and lagging sectors within the overall market, as well as determine the strength of one market or ETF compared to another.
That way, you can fine-tune your portfolio allocation toward the best performing trends to capture more profit potential.
At the moment, it’s clear that Healthcare continues to exhibit strong sector leadership, and Industrial stocks are rotating into a leading position among cyclical shares, while Materials are struggling to regain upside momentum.