A Look at Sector Rotation and the Trend in Long Term Treasuries

World markets remain volatile, pushed and pulled and battered by multiple forces including, rising interest rates (with strong ADP payrolls and rising US wage inflation supporting the case for more Fed rate hikes), the swift and violent reaction (in both directions) to corporate earnings reports, and political developments including elections and trade war speculation.

We’re coming out of October, historically one of the most volatile months of the year for stocks, and moving toward the end of the year which historically has been a time where investors pick up the pieces and start to look to the coming year with optimism. This year, however, we could see the period of higher volatility drag on into mid-November and the end of earnings season. That being said, with the VIX coming down off its recent highs, the worst of the selloff may already have passed, and correction lows may already be in place.

There are a number of significant developments in the coming days that could still move markets including Friday’s nonfarm payrolls and Canadian employment reports, and next week’s US midterm elections. The flood of earnings reports continues but shifts from the big cap sector leaders down into the mid and smaller cap companies. The number of reports increases but the impact of each report on the broader market diminishes.

In this issue of Equity Leaders Weekly, we take a look at what action at the sector level can tell us about current stock market sentiment, and also at how the bond market may continue to struggle even if stocks stabilize.

Sector Scopes Monthly Update

The Sector Scopes reports, which can be located in the Markets section of the SIA Charts website, measure the Bullish Percent (percentage of stocks on bullish technical signals) for 31 sector groups in the US market. Looking at changes in the reports over time can tell us which groups have become overbought or oversold, and where capital is flowing within the market.

The selloff of recent weeks has pushed most sectors leftward (falling bullish percent) to the point that most groups are piling up in the three leftmost columns and looking pretty oversold. Comparing where sectors are at this week with the end of January, one could say that the groups are as oversold now as they were overbought at the end of January, just before US interest rates broke out and the stock market sold off.

The two reports also show that the groups most in gear with the market (rightmost column in January, leftmost column in October) have been Aerospace, Manufacturing and Financial Services. In contrast, the two sectors that have diverged the most from the majority, and perhaps been the least volatile, have been Utilities and Real Estate. This is interesting because these groups are vulnerable to rising interest rates which suggests that the latest market correction has been more about bringing previously sky-high earnings expectations or market valuations back to Earth, and less about the liquidity fears and rising interest rates that kicked off the February market retreat.

SPDR Portfolio Long Term Treasury ETF (SPTL)

One of the biggest forces impacting sentiment across asset classes has been the shift from a low interest rate, pedal to the metal stimulus regime at major central banks, to one of rising interest rates in North America, and the tapering of asset purchases in Europe. The impact of central banks ending the easy money party of the last decade has created an intermittent headwind for stocks and a consistent tailwind for the US and Canadian Dollars.

Rising interest rates and the prospect of more increases in the coming year has had a persistently negative impact on bond prices. The SPDR Long Term Treasury ETF peaked nearly two years ago, in contrast to US indices which peaked about two months ago. This steady decline in bond prices means that long-term treasuries have not been able to act as a safety net during this year’s stock market selloffs and may not participate in rebounds either. Because of this, investors have started to look elsewhere for havens into shorter term holdings like cash, and even back into gold for brief periods of time.

This Friday, US nonfarm payrolls and Canadian employment reports are due. While the headline numbers may attract most of the attention, the numbers related to wage inflation may have a larger and more lasting impact on bonds. The US Q3 employment cost index came in above expectations and a high average hourly earnings figure may increase pressure on the Fed to keep raising rates for longer no matter what the politicians think.

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