The past few week’s domination by the defensive sectors, Healthcare, Utilities and Consumer Staples, experienced a perceptible shift towards the cyclicals over the last five trading sessions. How much traction do cyclicals have is the real question.
From a higher elevation, a look at our sentiment indicators shows the dominant trend away from risk appetite: High Yield/High Quality Corporates (HYG/LQD) remains in a decline, with lows since mid-December rising. This is positive in the short-term. The BofA ML US Corporate Option Adjusted Spread, which measures investment-grade corporates against Treasuries, has been in decline since 2009’s peak until bottoming June of 2014. The greater significance of this indicator underscores that in a market dominated by overvaluation, both long-term and short-term, sentiment is key for gauging reward/risk and managing positions.
BofA Merrill Lynch US Corporate BAA OAS
Closer to the ground, Consumer Staples was displaced from third place in our sector relative strength league table by Information Technology, with Consumer Discretionary and Industrials in tow. It is problematic that the Financials have not been participating in this shift in leadership. Financials also led the cyclicals lower through December’s correction, and this bears higher scrutiny ahead.
A few subsectors bear watching. Apparel Retailers have recovered approximately half of the sell-off from mid-December highs. This level was overhead resistance at the end of November, and support the first week of January. As such, we would characterize the group near a key support/resistance level as more sensitive to earnings fundamentally, and risk appetite at a higher level. Aerospace & Defense surged last Thursday, enabling the subsector to regain and exceed mid-December highs. While there appears to be a rising wedge structure to price, a structure that implies a possible retest of its 200-day moving average, there is room for short-term gains.
Managing Director, Chief Market Strategist