Sunday, August 23, 2009

Sector Update for August 23rd

Last week's sector update emphasized rotation and a broad topping process in stocks. Monday's weakness was followed by a bounce on Tuesday and a reversal of subsequent weakness early on Wednesday, which kept us above Monday's lows. After that, it was off to the races, as stocks moved steadily to new bull market highs.

Recall that Technical Strength is a proprietary measure of short-term trending. It can be conceptualized as akin to a regression line, where trend is a function of both slope and goodness of fit. As you can see from the chart above, we have seen neutral or bullish trend readings across the eight S&P 500 sectors since the early July lows. Indeed, the most recent week's data (orange bars above) show an improvement in trend to the upside. That is not what we typically see in markets that are topping out. Thus far, stocks have shown strength and, as noted in this past week's tweets and blog posts, an impressive ability to bounce back from short-term weakness. That suggests that money on the sidelines has been aggressive in using weakness to find good long side entries.

Here is how the Technical Strength readings sorted out by sector as of Friday's close:


Technical Strength varies by sector from a maximum high of +500 (strong uptrend) to a minimum low of -500 (strong downtrend), with values between -100 and +100 suggesting no significant directional movement. Note the consistent bullish readings across the sectors, with notable week-over-week improvement in sectors that reflect economic strength: materials, industrial, energy, consumer discretionary, and technology. Clearly the market is reflecting favorable economic reports and signals, anticipating continued recovery.

All that having been said, it is not clear to me that the recent highs are not part of a broad topping process. Of the 40 stocks in my basket that go into the sector readings, only 11 made fresh bull market highs on Friday. We see new highs lagging among the broad universe of NYSE, NASDAQ, and ASE shares as well, as my tweets on Friday indicated. If, indeed, we are to see toppy action, that should commence early in this coming week with notable weakness across sectors. If we do not see such weakness, it means that we are accepting value at higher price levels which, of course, is what bull markets do.