Tuesday, June 25, 2013

Defensive sectors shining of late

Since the market selloff on June 19th, defensive sectors have been doing their thing, hanging in there quite well on a relative basis.

Source: Stockcharts.com

The S&P 500 is off about 5% from its peak last month with the bulk of the loss coming in just the last few days (since June 19). I've been on the sidelines for several weeks now, expecting a correction, and the pullback has been a healthy one until more recently. For me to get more constructive on the market, one thing I want to see is the more cyclical, risk-on sectors begin to outperform. As always, I will be keeping a close eye on relative sector returns.

I will say that with this decline, I continue to not (yet) see signs of cataclysmic danger. Yes, I am and have been concerned, letting prudence dictate my actions. However, I wouldn't describe my tone or bias as five-alarm bearish. The indicators and charts I track simply haven't conveyed anything warranting such a dire posture. Not yet anyway.

As an example, the chart below shows high-yield "junk" bonds vs. the TLT, with the S&P 500 Index in the upper inset:

 Source: Stockcharts.com

The relative performance of high-yield bonds vs. TLT is another risk-on/risk-off surrogate, with a rising relative line inferring risk-on or heightened investor appetite for risk (bullish for stock market). Note that in the past the relative performance of junk bonds vs. TLT has tended to put in a top before that of the S&P 500 Index, creating a negative divergence. However, currently we're seeing quite the opposite as the Index peaked in May and has been in decline, whereas the HYG:TLT relative line recently hit a higher high, exhibiting no signs of a bearish divergence.

The weight of the evidence could change quickly in this environment, understood. But as of today, this market pullback has been overdue and remains just concerning, not (yet) hair-raising.

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