Tuesday, January 21, 2014

Is the amazing run for consumer discretionary stocks coming to an end?

Last October, I asked the question, "Is sector leadership changing?" At the time, relative sector performance was getting somewhat blurry and there were indications of a potential changing of the guard in sector leadership, with the consumer discretionary sector in particular showing uncharacteristic relative weakness.

As a reminder, since the stock market low in March 2009, by far the best performing major U.S. sector has been consumer discretionary/cyclicals.

As I wrote last August:
With the world seemingly coming to an end financially, in large part due to a deeply in-debt and beyond-extended U.S. consumer, the last area most experts thought would do well over the next several years would be the consumer cyclical/discretionary sector. These stocks were deemed a no-brainer must-avoid. Judging from the chart below, such stocks have not performed all that badly (!), in my mind putting together one of the most stellar periods of outperformance since tech stocks in 1999 to early 2000.
However, since December 18th of last year, the day Bernanke offered more clarity on plans for Fed tapering, effectively launching this most recent market rally, sector performance has been interesting.

The chart above shows absolute returns for the S&P 500 Index and the nine major U.S. sectors. Note that I use the Guggenheim equal-weight sector ETFs, which reflect a truer depiction of performance as they are less prone to being skewed by a few mega-cap constituents. The S&P 500 is up 1.55% with health care, industrials, materials and technology sectors outperforming the Index. What's most interesting is all sectors have achieved positive returns since December 18th -- except the consumer discretionary/cyclicals sector, posting a woeful -1.5% absolute return.

This surprising underperformance is further made evident in the following charts.

In just the last few weeks, the relative price of the XLY has broken down through a well-defined, 17-month ascending trend line. Note in the chart above the bearish divergence occurring in the MACD, clearly deviating from the rising trend in relative price.

A similar picture holds true when viewing the equal-weight consumer discretionary sector ETF (RCD) versus the equal-weight S&P 500 ETF (RSP).

As with the XLY, the relative performance of RCD broke trend this month, quite drastically I might add, and again the MACD exhibits a bearish divergence.

Let it be said that the consumer discretionary/cyclicals sector has been counted out before only to right itself and continue on its impressive, and in many ways, confounding run. And that may once again be the case here, with the sector taking a breather of sorts after a prolonged period of uninterrupted outperformance. But the sector's recent lag in both absolute and relative returns is very conspicuous and even striking when you consider it has greatly deviated from all other sectors, and that even the seemingly perennial-underperforming utilities sector has been able to eke out a +0.35% gain. In short, outlier price action is always worth keeping a close eye on.

As for sectors appearing bullish at this point, the industrials sector is one.

The above chart shows the equal-weight industrials sector ETF (RGI) vs. the equal-weight S&P 500. Late last year, the sector successfully broke out of a massive triangle formation and has since been on a relative-return tear.

Another sector exhibiting a bullish relative chart is health care.

The equal-weight health care sector ETF (RYH) has been steadily outperforming the equal-weight S&P 500 for the past two years, but this month relative price kicked into another gear and broke out of a rising wedge formation. A pullback often occurs after such a breakout, as momentum pauses and looks to reenergize.

It's worth mentioning that the recent outperformance of the health care sector is not due to one or two high-flying industry groups. Although biotech stocks have certainly been stellar performers, market-beating returns have occurred across several industry groups in the sector. The chart below shows performance in the period for the S&P 500, biotech, pharma, medical devices and HC services, respectively.

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