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The Lead-Lag Report: Nearing Changes Everywhere

“Strength and growth come only through continuous effort and struggle.” – Napoleon Hill

Below is an assessment of the performance of some of the most important sectors and asset classes relative to each other, with an interpretation of what underlying market dynamics may be signaling about the future direction of risk-taking by investors. The below charts are all price ratios which show the underlying trend of the numerator relative to the denominator. A rising price ratio means the numerator is outperforming (up more/down less) the denominator.

LEADERS: INVESTORS NOT WORRYING ABOUT RECESSION

Technology (XLK) – Market Leadership Continues

Technology Select Sector SPDR Funds continues to increase

Comments: Stronger than expected economic data from China gave the tech sector another boost this week pushing its lead over the S&P 500 this year to nearly 9%. Further global monetary easing and another successful round of Chinese fiscal stimulus look to provide a steady tailwind for this group.

Materials (XLB) – Struggling for Direction

Materials Select Sector SPDR Funds continue to decrease

Comments: This sector has bounced around relative to the S&P 500 for much of the past six months but it’s safe to say that prospects for materials stocks have improved. Demand for things like new home construction and the materials involved with it are looking stronger and valuations remain reasonable. As cyclical stocks have remained in favor, XLB has beaten the S&P 500 by nearly 300 basis points over the past three weeks.

 Consumer Discretionary (XLY) – Riding Strength in Cyclicals

Image of recovery of Consumer Discretionary Select Sector SPDR Funds

Comments: A strong recovery in jobs and a possible economic bottom in China are pushing off recession fears and increasing demand for cyclicals. Low inflation, solid GDP growth, and an accommodative Fed are providing the perfect storm for investors to add risk to their portfolios and consumer discretionary companies are some of the biggest beneficiaries. Gas prices continue to rise and could hamper consumer spending over the high demand summer months.

Industrials (XLI) – Another Failed Breakout

Image of another failed breakout of Industrial Select Sector Funds

Comments: The industrial sector is still heavily influenced by Boeing and General Electric, both of which have been the recipients of bad news lately. Boeing is working through its very public 737 MAX issues while JP Morgan downgraded GE calling its rebound overdone. The industrial group is still beating the S&P 500 year-to-date but several instances of failing to carry through on short-term rallies suggests that momentum is diminishing.

Long Bonds (TLH) – Halting the Spike in Interest Rates

Image of halting spikes of Treasuries

Comments: Treasuries suffered over the past few weeks from a rapid spike in rates but the bleeding appears to have slowed if not stopped altogether. Traders continue to rotate out of safe-haven assets as the cyclical growth story continues to play out. The longer-term uptrend still remains in play but rates may begin inching back up if the economy is able to stave off a recession.

Junk Debt (JNK) – Taking a Bit of a Breather

Image of Junk debt showing signs of improvements

Comments: Junk debt had another solid week with the year-to-date gains on long-term bonds now approaching 10%. There’s a case to be made that further gains from here could be limited as BB-rated option-adjusted spreads are at some of their lowest levels since just before the financial crisis. For now, high yield bonds continue to ride the wave of the risk-on rally.

Treasury Inflation Protected Securities (IPE) – Modest Demand

Image of Treasury Inflation Protected Securities drop in the past few months

Comments: TIPS yields have dropped noticeably in the past few months but they still remain in positive territory. That makes them relatively attractive but demand likely won’t tick up significantly until there’s some inflation in sight. That along with the general rotation out of Treasuries lately has TIPS in a wait-and-see mode.

LAGGARDS: LOW RISK, NO RALLY

Small-Caps (SLY) – Setting Lower Lows

Image of small-cap group continues setting lower lows relative to the S&P 500

Comments: Small-caps haven’t rallied in the way some might expect given the market’s preference for risky assets. The concerning trend is that the small-cap group continues setting lower lows relative to the S&P 500. Earnings forecasts for Q1 have taken a dive with analysts now expecting a double-digit decline, far lower than estimates for large-caps. Traders appear to be sticking to the areas with a better outlook.

Financials (XLF) – The Trend is Not Your Friend

Financial Select Sector SPDR Funds image dropping signifcantly

Comments: Q1 earnings for the big banks have been a mixed bag despite low expectations. Concerns that earnings growth is fueled by share buybacks contributed to dampened optimism about earnings quality. The macro story remains the same. Balance sheets will be impacted by low-interest rates as financials attempt to diversify their business lines.

Health Care (XLV) – Turning Toxic

Graph showing the straight down decline in healthcare stocks relative to the S&P 500

Comments: The straight down decline in healthcare stocks relative to the S&P 500 is approaching the six-month mark with no end in sight. Healthcare providers are the biggest drag on the index due to uncertainty over the future of the Affordable Care Act although biotech and medical devices have performed relatively well. Johnson & Johnson delivered solid Q1 earnings on Tuesday providing some hope that things could improve.

Utilities (XLU) – Still Giving Way to Risk-On Assets

Graph of Utilities Select Sector SPDR Funds

Comments: The cyclical trade remained intact this week which means the defensive-oriented utilities group remained out of favor. Despite the focus on risk assets, bullish sentiment on the utilities sector remains at extremely high levels. Investors will focus on how interest rates have affected balance sheets this earnings season since utilities and their high debt levels could be positively affected by falling rates.

Energy (XLE) – Stuck Below the 20DMA

Image of Energy sector showing a dip

Comments: Oil prices have risen nearly 40% this year but that hasn’t translated into outperformance for the energy sector. Rising prices coupled with efforts to curb production are being offset by concerns over global economic weakness affecting demand. Historically, the correlation between oil prices and stock prices is higher which could make the energy sector an interesting value play.

 Consumer Staples (XLP) – Turning Quiet

Image showing consumer staples group continuing to lag in 2019 as investors reduce defensive positioning

Comments: The consumer staples group continues to lag in 2019 as investors reduce defensive positioning. Continued strength in the jobs market along with steady GDP growth and low inflation should keep investors searching elsewhere for higher returns. Also worth noting that trading volume in the sector has been significantly lower than 2018 confirming a general lack of buying interest.

Emerging Markets (EEM) – Forming a Solid Base

Emerging markets graph

Comments: Foreign equity markets continue to lag the U.S. market but emerging markets are showing signs of establishing a short-term bottom. Eurozone weakness has dragged developed markets lower but emerging markets have begun demonstrating relative strength by keeping pace with the S&P 500 over the past three months. Emerging markets remain attractively valued and while value is still out of favor it offers contrarian investors an intriguing buy-low opportunity.

Europe, Australasia, and the Far East (EFA) – Drifting Lower on Recessionary Fears

Image showing drifting recessionary fears of large markets

Comments: Large markets like Italy and Germany could slip into recession at any minute and even France reported a negative real GDP number in the most recent quarter. The United Kingdom looks like it might be getting a brief reprieve from the Brexit drama but overall sentiment in developed foreign markets remains comparatively weak despite 13% returns in 2019.

Bonds (TLH) – Getting Left Out to Dry

10-20 year treasury bond graph

Comments: Long-term bonds have performed well this year but investor preference lies with equities. Corporate balance sheet strength and declining interest rates have helped the fixed income market but traders continue to load up in equities until domestic economic data tells them to do otherwise. The VIX is back around 12 and equities tend to slowly drift north in that type of pervasive low volatility environment.

Conclusion?

The biggest gains lately appear relatively contained to large-cap tech and cyclicals. In general, investors appear satisfied that a recession in the U.S. is not coming anytime soon which should be a tailwind for equities in the short-term. The S&P 500 is just 1% off of its all-time highs and appears prepared to punch through and make a run at the psychologically important 3000 level.

Purpose:

This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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