What I Saw ( Week of 12.8.14 )

Tuesday of this week I expressed a mildly bearish sentiment regarding the broad market. Based on stock market internals including weakening market participation, the duration and velocity of the near vertical bounce off of the October lows it seemed increasingly likely that we would see some profit taking and some sort of correction. Let's see if this estimation was validated by the market. 

I would say it looks like market participants did decide it was a good time for profit taking/risk reduction. Overall this week, SPY/$SPX is down ~ -3.5%. As of this post on Tuesday down ~ -2.7%. Let's take a look at the other major indices. 

Let's break it down by sector. This way we can see if the selling was concentrated and if so which sectors are out(under)performing. 

Note the difference in calculated weekly performance. The top chart is a bottom up calculation by finviz.com generated using all the available stocks within each of their sector categories. The second chart is from stockcharts.com and it is the trailing 5 day return of the S&P SPDR Sector ETF's relative to ( SPY ). 

After that clarification, we can clearly see the selling is concentrated in the Energy ( XLE ) and Basic Materials ( XLB )  sectors. This reflects current analyst and investor sentiment regarding potential 'demand slow down' in the face of rising raw material supply. 

Also note the strong relative performance within utilities ( XLU ), cyclicals aka consumer discretionary ( XLY ) and consumer staples ( XLP ). This indicates buying based on two trends.

1) The US consumer is back in a major way due to the continued persistent decline in oil prices (more on that later).

2) Defensive re-balancing taking place (read: lower expected risk). The correlation between broad market weakness and defensive sectors like consumer staples/utilities is buoyed by the following simple concept: 

A LOT of the largest institutional investors (mutual funds, pension funds, insurance funds) have "long only", "fully invested", or "cash balance maximums" mandates imposed on their stock investment strategies. Therefore profit taking, or risk reduction, means they cannot sit on excess cash. It must be reinvested. Well that means if, as a portfolio manager,  you believe market risk (volatility) is high (increasing), considering the aforementioned constraints, you must decrease your exposure to stocks that are really sensitive to market changes (high-beta, growth, momentum, high leverage) and increase your exposure to stocks that are less sensitive to market changes (low-beta, value, defensive, low leverage).

See below:

Hard to argue with the above. This chart shows the last 5 days' performance for a few of the largest US utilities, the S&P Spdr Utilities ETF ( XLU ),  all relative to ( SPY ); SPY 5 day performance is = 0%. This gives us a much clearer picture of the relative outperformance of the utilities sector vs the broad market. 

Oil is still a blood bath. 

OIL -13%

Brent -10.45%

WTIC -13.06%

YTD:  - 40%+

What I'm Watching ( Week of 12-8-14 )

How long does equity optimism last without correction?

Over the weekend I examined the market internals and came away mildly bearish at these levels. Extreme optimism and lack of participation among the broad indexes make this a week ripe for profit taking and I've been aggressive with my trailing stops etc during the last 2 trading sessions. 

When will OIL finally bounce? Have investors finally capitulated?

I'm short oil via the Inverse ETF SCO ( wish I had more size ) however this has been a profitable position ever since OPEC's decision not to lower production targets. Clearly this is an example of geopolitics setting up incredible trade opportunities. However the contrarian value hunter in me knows the devastation in energy producers' stocks is likely a case of throwing the baby out with the bath water. There are plenty of firms out there able to produce at a profit even in today's low oil price environment. I will be looking to rotate into those as soon as it's prudent to do so. 

If you bought SCO the day after the OPEC decision you would be sitting on an approximate 17% gain based on today's levels!