Saturday, May 30, 2009

Was Friday's Late Rally the Start of Something Big?

I received quite a few emails asking my opinion about Friday's late surge in the stock market averages, which saw SPY touch a post-crash bull high before pulling back slightly below its prior high of 5/8/09.

The long and short of it is that I don't see good leadership in the recent strength. For example, Friday's market registered 1401 new 20-day highs against 351 new lows across the NYSE, NASDAQ, and ASE. That compares with 2862 new 20-day highs and 224 lows on May 4th and 2199 highs and 245 lows at the closing price high of May 8th. At least for now, fewer stocks appear to be participating in the strength.

The chart above may help to explain why. I've charted the relative performance of three key sectors--financial stocks (XLF), homebuilding stocks (XHB), and consumer discretionary stocks (XLY)--and plotted that from the May 8th price high to Friday's close. What we can see is that, throughout most of May, these sectors have underperformed the S&P 500 Index (SPY).

Conversely, the more defensive health care (XLV) and consumer staples (XLP) sectors have outperformed SPY since that time.

It seems to me that if the market is discounting a lasting recovery, we should see continued leadership from the beaten down financial, homebuilding, and consumer discretionary shares. Stated another way, it is difficult to imagine a sustained bull market in which we don't see optimism expressed toward banks, housing, and the consumer.

An opinion contrary to the late Friday exuberance is that, with the falling dollar and rising Treasury/mortgage rates, not to mention the prospect of reflation/inflation, the stock market is beginning to see greater leadership from defensive sectors than from growth-oriented ones.

Friday's rally may be the start of a big upside breakout; if so, the indicators that I track weekly on the blog and daily via Twitter should capture the expanded momentum and participation on any follow through next week. For now, however, I remain agnostic.