One of the characteristics of a trending stock market is sector rotation. In a bull market not all sectors are necessarily trending higher and sectors are taking leadership in turns. This means that some are bound to outperform while the others are under performing. Sector rotation is a very important fuel of a bull market. So identifying sector rotation is crucial to be successful in the stock market. The phrase past performance is not an indication of future results is something that applies here very well!
We’ve seen increased volatility in the stock market this past week. I think that the reason could have been due to a rotation and not because a major top is forming just yet.
Let us a take look on the monthly chart of XLK Technology sector ETF.
We see that the price reached a crucial level of the 2000 top. I would be expecting the price to consolidate here, especially after the gains in the recent periods.
On the other hand XLF Financial sector ETF has still more than 10% upside before reaching 2008 highs.
Between where we are and 2008 highs the price does not offer major hurdles therefore one should expect the path of least resistance to be up.
Not only that, if we take a look at the ratio between XLF and SPY we see that XLF is trying to bottom here by creating higher highs and higher lows and start out performing the broad-based index.
If a major top would be in the making, don’t you think that financials should be under performing in that case (similar to ’08-’09)?
By doing the same analysis one could come to similar conclusions regarding XLE Energy sector ETF. I have not only tweeted but mentioned XLE many times in my posts lately.
It is challenging the falling trend line on the weekly chart above. A successful break through could mean that more gains should be expected where the path of least resistance should be to $78 at least.
Before I finish I have to write a note of caution. A reader of my blog knows that I am a US dollar bear. Similar to rotations in the stock market there are rotations in the currency market. I am writing this with a reason because e.g. EURUSD has big implications on the European stocks.
Despite my bearish views on the dollar I would be expecting EURUSD to trade sideways for some time. If the euro will be trading aggressively higher the European stocks could see a correction. This could also drag other stock markets lower.
Below please see the monthly chart of an equally weighted index of German DAX, French CAC, Italian MIB and Spanish IBEX.
If the short-term support at the current levels doesn’t hold I wouldn’t be surprised if we get a 5-10% correction. Should the support hold it will create a very positive signal for stocks.