Will 2013 Favor Risk-on or Risk-Off Trades?

01/17/2013 6:00 am EST

Focus: ETFs

Corey Rosenbloom

Founder and President, Afraid to Trade

When looking for swing trades or short-term plays, it helps to concentrate your attention in leading sectors, says Corey Rosenbloom of AfraidToTrade.com.

As we turn the corner into 2013, there are four main AMEX Sector SPDR ETFs that have exceeded and trade well above their 2007 bull market high.

Two ETFs are in the “offensive” sector while the other two are in the “defensive” sector, which makes an interesting situation.

Let’s take a quick overview of these four ETFs and assess what this suggests about the current market.

XLY Consumer Discretionary (Offensive):

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XLK Technology (Offensive):

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XLP Consumer Staples (Defensive):

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XLV Health Care:

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While these are the four major sector ETFs that have broken above their 2007 high, we also must note that the following ETFs have broken their 2012 high:

XLF Financials
XLI Industrials
XLB Materials

This means that the following Sector ETFs have NEITHER broken their 2012 recent high or 2007 high:

XLU Utilities
XLE Energy

What does this mean for the broader market?

When assessing sector performance, it’s best to classify these nine major sectors into “risk on” or “risk off” sectors.

Strength (money flow/relative strength) into risk-on sectors (discretionary, financials, industrials, materials, energy, and technology) suggests broader market strength and argues for bullish future price action (generally safe to invest).

However, strength into risk-off or defensive sectors (health care, utilities, consumer staples) suggests that market participants are cautious about the future and are pulling risk from the high-beta sectors, which suggests future weakness for the broader market (at least in the short-term).

It’s bullish to see strength in technology and consumer discretionary sectors but puzzling to see similar strength (at least on the longer-term chart) in defensive staples and health care.

It suggests—as may be commonly assumed—that investors continue to be cautious and somewhat distrusting of the broader bull market that has occurred from the March 2009 low.

When looking for swing trades or short-term plays, it helps to concentrate your attention in leading sectors (those that are currently outperforming the S&P 500 Index).

The general thesis is that in a rising market, the “offensive” sectors will outperform the “defensive/safe” sectors and—by proxy—should outperform the S&P 500.

Carrying the thought further, leading stocks (be it through relative strength or fundamentally) in leading sectors should offer opportunities for additional outperformance relative to the S&P 500.

Hedging strategies may also be developed using sector analysis (long strong stocks in strong sectors; short weak stocks in weak sectors) but that’s a topic for much more discussion.

For now, we’ll just highlight the price performance of the last few years in these main sector ETFs and note the unusual strength in these four ETFs that have broken above their 2008 high.

It’s easy to miss these factors if we simply chart on a daily chart for very short-term plays so be sure to look to the higher timeframe as in this example.

By Corey Rosenbloom, CMT, Trader and Blogger, AfraidToTrade.com

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