Sector Rotation Is Key, Watching for Breakouts in Energy and Materials

Here are my market comments for SFO Magazine this morning:

SFO Daily: Sector Rotation Is Key, Watching for Breakouts in XLE and XLB

Friday, January 6, 2012
By J.C. Parets

The S&P 500 has closed in positive territory for three consecutive days to kick off 2012. The recent leadership, however, has come from stocks with higher market capitalization. For the stock market to move substantially higher, we want to see breakouts out of the smaller cap names.

The Dow Jones Industrial Average, Dow Jones Transportation Average, Nasdaq100, and S&P 500— typically known for their large-cap components are all above their 200-day moving averages. Unfortunately, the Russell2000 Small-Cap Index and S&P 400 Mid-Cap Index have yet to break through that key resistance. The lack of participation there is a bit worrisome.

SECTOR ROTATION

We also want to see strength and outperformance from some of the more aggressive sectors of the market. Throughout 2011, the leadership came from Utilities, Consumer Staples, and Healthcare —the defensive sectors in the S&P. With that sort of leadership, the stock market struggled last year, specifically in the second half.

For the Dow Industrial Average and other large-cap indexes to hold these key breakout levels, we need to see rotation into some of the more offensive sectors of the market. We want to see breakouts in Energy ($XLE) and Basic Materials ($XLB) which have yet to break above their all-important 200-day moving averages. The Industrials ($XLI) are the first to attempt just that, closing above the 200-day average every day this year.

Sector rotation is an important characteristic of a bull market. For U.S. stocks to continue their excellent 2012 start, the small-cap names and offensive sectors need to, not just participate, but lead the market higher.

So far so good as the top performing sectors of 2012 have been Basic Materials, Financials, Industrials, Energy, and Consumer Discretionary. The worst performing sectors so far this week have been Utilities, Healthcare, and Consumer Staples, which have all dramatically underperformed the S&P500. (click chart to embiggen)

GOOD CLUES

These stats are usually a nice tell for the upcoming year. Since 1950, when the S&P 500 is up over the first five days of the year, the rest of the year has been positive 33 out of 38 times. As far as component performance is concerned, the best industries in January are typically the best performing industries for the rest of the year.

You want to see more of the same if you think that 2012 will be positive year for U.S. equities. The relative performance from the offensive sectors of the market is essential for a bigger stock market rally. The breakout in the Industrial sector is a good start, but follow-through in Energy and Materials might be the key to new three year highs in the S&P 500.

Source:

Sector Rotation is Key, Watching for Breakouts in XLE and XLB (SFO Magazine)

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