I wanted to get into a little bit more detail about my favorite new sector rotation tool. Bloomberg recently came out with the Relative Rotation Graph function to help analyze shifts in leadership. You guys know that I believe sector rotation and the right leadership is essential to strong markets. The opposite is also true as defensive areas tend to outperform during market corrections. The internals tell us a lot. We discussed this briefly in a post this week, but this new tool is that awesome that it deserves its own blog post.
The way the function works is that it breaks your universe of stocks into four quadrants: Improving, Leading, Weakening and Lagging. The x-axis in the graph represents the relative strength and the y-axis measures the momentum in that relative strength. So if the data is plotted in one of the quadrants to the right (Leading or Weakening) then the security is outperforming its benchmark. When it’s on the left side (Lagging or Improving) then it’s underperforming. Now if the data is in one of the bottom quadrants (Weakening or Lagging) then its relative performance is decreasing in momentum. When it’s plotted in one of the upper quadrants (Improving or Leading) then its relative performance is increasing in momentum. Hence the relative rotation graph.
Here’s a look at the daily chart where Financial leadership seems to be coming to an end as it falls into the Weakening category. Materials and Industrials appear to be following along. On the improving end, we can see that Consumer Staples are getting better with a more sustainable trend (outer bands):
Here is a look at the weekly chart, which might show us what’s happening in the bigger picture. Financials are confirming their drop that we see in the daily chart by coming down towards the weakening box, yet still outperforming. Consumer Discretionaries, Industrials and Materials are Leading the way here with Tech, Energy and Utilities still lagging. We’re watching Utitilies closely here as momentum continues to improve.
This is an article that technician Paul Ciana wrote for Bloomberg Markets on this subject. I think he does a nice job explaining the function as well as some of the advantages that this tool brings to money management.