Sunday, April 19, 2009

Comparing the Technical Strength of Sectors

At a reader's suggestion, I have compiled the last five week's data on Technical Strength for eight S&P 500 sectors and displayed them above. This gives us a quick visual look at which sectors are strongest and weakest and which are gaining and losing strength.

Technical Strength is the name that I gave to a proprietary indicator that measures short-term trending behavior. Basically, a stock, sector, or index can be said to be trending if it has a high ratio of directional movement to total movement. The Strength readings for each sector vary from +500 (strong uptrend) to -500 (strong downtrend). Readings between -100 and +100 suggest no significant trending.

Each morning before the market open, I post to Twitter the Technical Strength status of the 40 stocks in my basket (five of the most highly weighted issues in each of the above eight sectors). This is a great way of staying on top of the market's day-to-day shifts in trending behavior.

Notice that almost all of the bars are above zero. Right away that tells you that we've been in an intermediate-term uptrend. That might seem obvious, but you'd be surprised how many people have been emailing me for the last several weeks, telling me that the rally is phony, that it's about to turn, that it's not grounded in fundamentals, etc. Perhaps that will prove to be worthwhile investment advice. It is worse than worthless as trading guidance.

When the great majority of stocks are moving in sync, that's not usually when markets sustain a turnaround. Rather, prior to important reversals, we see rallies peter out, with fewer stocks registering fresh new highs and fewer stocks and sectors sustaining their Technical Strength. Lately, we've seen strength in the Materials sector (note the rising Technical Strength week over week, above) and among the Financial stocks. The Materials shares are reflecting growth themes, especially among emerging economies. The Financial stocks are reflecting growing optimism regarding bank recapitalization. It is difficult to sustain the downside when these themes are dominant.

That having been said, look at the last two column bars for each of the sectors. Some of the sectors gained Technical Strength on the week, others lost a bit. This kind of mixed performance while the overall S&P 500 Index is making new highs suggests that the rising tide is not lifting all ships equally. I am watching this carefully, as such slowing down of strength is what we'd expect to see prior to a market consolidation (See the recent indicator post for further evidence of a slowdown in market strength).

Finally, watch that XLY to XLP ratio; it's a nice indicator of growth interest vs. defensiveness among stock traders. It pulled back last week, as the chart indicates; we also pulled back in XLF, which strongly reflects banking stock interest. Those themes will be front and center as we start next week's trade.