Sector Analysis: December 2008

12/18/2008 11:02 am EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

I last looked at all the sectors using data as of the close on July 11, 2008  (click here for article), and at the time, noted the recent carnage in the markets. Had I only known that the first half of the year would turn out to be the good part! The goal of this article is to review the analysis of the July article, and then to bring the sector analysis up-to-date, as it may help us in the first quarter of 2009.

The table above looks at the ten major market sectors, along with the S&P 500 Index. We have taken the recent close (12.12.08), along with the 2007 ending price, and the 7.11.08 ending price. I have selected these dates in order to gauge: 1) how the sectors have done this year, and 2) how well they have done since our July update. First of all, for those of you who have not read my earlier articles on sector analysis, I use a relative performance (or RS) that is determined by calculating a ratio of the sector price to the S&P 500. When the RS line is rising, it means that the sector is performing better than the S&P 500. Conversely, if it is declining, it is underperforming. Then we also look at breakouts or breakdowns for changes in the relative performance.

Figure 1

The biggest disappointment from the July article was the action in the energy sector, as the week after our report was released, the RS violated its WMA (line 1) and then dropped sharply for the next four months along with crude oil prices. Often times we see a divergence between prices and the RS before such a sharp decline, but one did not form in July. It was the best performer for the year from the July report, and I thought it would continue to outperform the S&P 500, but it did not given that the S&P is down 29%, versus a 36% drop in the energy sector since July. Over the past few weeks, however, the technical picture has improved, as the RS has turned up from support, and the uptrend that goes back to 2004 is still intact. It is back above its WMA, and a move above the recent high in the RS (line d) should signal a new uptrend is underway.

The health care sector was one of our favorites in July, as it was only down 2% at that time, versus the 10% drop in the S&P. Health care has declined 19% since July 11th, which is 10% better than the S&P 500.  For the year, it is down 29%, which makes it the second best performing sector.

Figure 2

The long-term chart of the health care sector illustrates a good example of how sector rotation works. Let’s first go back to May of 2000 (line 1), when the RS turned positive as it moved above resistance and its rising WMA. For the next two years, as the major averages, especially the Nasdaq, were dropping sharply, the health care sector was holding up much better. The RS started to turn lower in early 2003, as it dropped below its WMA, and then the WMA started to decline. Important support (see line a) was broken in May (line 2). At this time, the S&P 500 was completing its bottom formation.  The RS formed lower highs and lower lows for the next few years until the RS rallied in late 2007 and early 2008. The RS then declined once more, but in June 2008, moved back above its WMA (see point c). By early July 2008, the three-year resistance (see line b) was overcome (line 3). The RS is currently well above its rising WMA and looks positive.

Figure 3

The most interesting sub-group of health care in July was biotechnology, and it continues to act well, down just 9% from July 11th. The RS moved through major resistance (see line a) the week of June 27th (line 1), and was already above its rising WMA. After breaking out from such a nice base, and with the WMA still rising strongly, it should continue to outperform.

Figure 4

Another sector that bottomed in 2007 and 2008 was consumer staples, as the resistance going back to 2004 (line a) was overcome in early November 2007. This sector is down 20% for the year, and only 14% from the July highs. This makes it the best-performing sector since our July analysis. The RS pulled back in early 2008, dropping below it’s WMA before giving a new positive signal in July 2008 (line 2), as it moved above its previous highs (see line b). No signs yet that this trend is changing, as typically we would see a several month or longer topping process before a change in leadership is indicated.

Figure  5

One of the sectors that has turned positive over the past few months is the telecom sector, as it is just down 17% since July, but on a yearly basis, looks worse considering it is down 35%. Looking at the long-term chart, an 18-month downtrend (line a) was broken in early 2006, as this sector rose about 80% over the next two years. The RS started to diverge at the October 2007 highs and turned negative early in 2008. This changed the week ending October 24th, as the downtrend in the RS (line c) was overcome. This positive signal was reaffirmed with the breakout above the resistance from 2007 (line b). At this point, the price chart of the sector shows a potential bottom formation, but this has not been confirmed.

Figure 6

By July 11th, the materials sector had already declined 14% from the April highs, with the RS bouncing off its uptrend (line c). Two weeks after our report, this uptrend was broken (line 1). Support for the sector was also pegged at 235, and then more importantly at 215-220 (line b). This second level of support was first broken in early September, and the selling picked up sharply the next month. The sector is now close to testing line a, which would be a retest of the breakout from 2003. The RS has also reached long-term support, but is still well below its declining MA.

Figure 7

One sector that, given the state of the economy, one would not expect to do well is the consumer discretionary, yet it is only down 22% since July. No signal yet that this sector is going to outperform the market, but the chart and RS pattern does look interesting. In particular, the RS shows three almost equal lows (see arrows), but needs to first move above the recent highs (line b) to complete the short-term bottom. A move through the longer-term downtrend (line a) would be much more positive. The sector still has major resistance in the 230 area.

Figure 8

Of course, the worst performing sector for the year is the financials, down 59%. As you will note in the table, they are not the worst since July, as they are down 36%, matching the energy sector, but better than the materials, which are down 44%. As noted in past articles, the RS line broke 5 ½ year support on July 6th, 2007, and continues to make lower lows. The WMA is also declining sharply, and it should flatten out before there is any hope of a turnaround.  The Financial Select Spyder ETF (XLK) closed the week of July 6th, 2007, just above $36, and has dropped below $10 in November.

If the economy does start to stabilize in 2009, we should see a rotation in the sectors before the worst of the economic news is out. For now, it appears that the traditional safe haven sectors, namely health care and consumer staples, will be the best bet, along with telecommunications services. The telecom group will need to be monitored in case the recent buy signal is reversed.

I hope all of you have a great holiday season! Trading Lessons will return in the new year.

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