Sector Analysis: February 2010

As the stock market undergoes its first meaningful correction since last summer, I wanted to take a look at the ten major sectors to see what had changed since the last sector analysis in August 2009 (read the August analysis here).

Table 1 - Click to Enlarge

The first thing that I found very interesting was that there were several sectors, like the Materials and Utilities, that had changed very little from the August 7 close. Only two were lower, the Financials and Telecommunication Services sectors. The best performer since August was Health Care, up over 11%, and unfortunately, it was a sector that I was not impressed with in August. Three sectors were up over 8%, including Information Technology, Industrials, and Consumer Discretionary.

Information Technology was the star performer for 2009, up 60% and much better than the Materials, which gained 45%. The Consumer Discretionary sector was up 39% and was also significantly better than the S&P 500, which was up 27%. Of course, if you look at the performance from the March lows, you get a much different picture. The Financial sector was up only 15% for the year, but up 147% from the March lows, outpacing the four sectors that were up over 80%. So how are the sectors performing during the current correction, and how does this compare with last summer’s pullback?

Table 2 - Click to Enlarge

The Materials and Financials had the largest corrections from the June highs to the July 2009 lows as they were down 17%, followed closely by the 16% loss in the Industrial sector. The Technology sector held up quite well during this correction, down only 8%, which was less than even the Utilities sector. Two of the more defensive sectors, Health Care and Consumer Staples, also held up well, losing 6% and 5%, respectively.

Using the late-2009 or early-2010 highs (labeled as Recent High on the table), let’s see how the current correction compares. Once again, the Materials have been hit the hardest, down 20%, which is 5% more than Energy, which is the second weakest sector. The Information Technology Sector was hit a bit harder this time, down 12%, while the Financials were down just 14%, as opposed to 17% last summer. It should be no surprise that Health Care (-9%) and Consumer Staples (-6%) have held up well during the recent market decline, as has the Consumer Discretionary sector, which is down just 8%. In my experience, I would expect those sectors that have held up the best to be the leaders on the next market rally.

Figure 1 - Click to Enlarge

First, let’s look at the weekly chart of the S&P 500. The positive divergence in the weekly RSI, line B, helped us to identify the market’s lows last March, point 1. The RSI did make marginal new highs below 70 in January, line C, but has since dropped sharply. The bullish divergence support at line B has just been broken (point 2), which is likely an early warning signal. If the S&P 500 moves above the January highs in the next few months, a more serious bearish divergence is likely to be formed. The daily studies are negative and show no signs yet that they are bottoming.

Figure 2 - Click to Enlarge

The Information Technology Sector reached the 23.6% support this week with the 38.2% support now at 310, about 10% below current levels. The rising 40-week moving average, equivalent to the 200-day MA, is now at 324. There is initial resistance at 360, and on a move above the recent highs, the long-term resistance zone is at 400-425. The RSI made slightly lower highs in January (73.97 vs. 74.07), but this divergence occurred at only moderately overbought levels. In my experience, divergences that form after a move above 80 or below 20 are generally more significant. It is negative that the RSI has clearly violated it uptrend, line b, and that the WMA is now declining. A rebound in the RSI that fails at the declining 21WMA would turn the outlook much more negative. It is also important that the RS broke above five-year resistance in 2009 (not shown), which generally has long-term significance.

NEXT: Timely Look at Materials, Industrials, and Financial Sector

|pagebreak|

Figure 3 - Click to Enlarge

The Materials Sector has already corrected 20% and is testing its slightly rising 40-week MA. There is further good chart support and the 38.2% retracement support at 170, about 7.6% below current levels. The correction in the summer of 2009 also tested the 40-week MA as it was flattening out. The RS chart, which looks at the relative performance of the sector versus the S&P 500, completed the bottom formation in March when it overcame resistance at point 1. The RS has made slightly higher highs, but is still in a trading range, lines a and b. The WMA has flattened out and could turn decidedly lower in the next few weeks. Some of the weekly studies have deteriorated, and a strong close back above 195 is needed to keep the intermediate-term trend positive.

Figure 4 - Click to Enlarge

In our last article on sector analysis, the Industrials were one of my favorites as the sector had completed a reverse head-and-shoulders bottom formation on the weekly chart. The target in the 280 area has not yet been reached as it has rallied from 215 to a high of 258 and the 50% retracement resistance. The 61.8% resistance level stands at 287. While the chart has looked pretty good, the action of the RS has not been that impressive as it has just barely moved through resistance at line a. The uptrend in the RS, line b, is positive, but a sharper rally is needed to turn the RS bullish and signal strong outperformance by this sector.

Figure 5 - Click to Enlarge

Though the Financial Sector is up 147% from the March 2009 lows, it is about 2% lower than it was last August (see table 1). It is down 14% from the highs made in October 2009, which is in line with the 17% correction last summer. The long-term daily chart shows that the financials have retraced just a bit over 23.6% of the decline from the 2007 highs with the major 38.2% resistance at 242. Currently, the financials are testing the rising 200-day MA with additional support in the 175 area. Within this sector, there are quite a few regional banks with very interesting charts.

NEXT: A Look at Consumer Staples, Health Care, and Energy

|pagebreak|

Figure 6 - Click to Enlarge

The Consumer Staples Sector is one of the more defensive sectors, along with Health Care. The Staples sector is up 37% from the March lows and 11% for 2009. During the first correction from the March lows, the sector declined 5%, which is pretty much equal to our current 6% decline. The daily chart shows first good support in the 265 area. A break below this level will suggest a test of the 200-day MA at 257, if not the 38.2% support at 250. There is long-term trend line resistance is in the 290 area. The weekly RS analysis has deteriorated some, which is not what I would expect during a market correction.

Figure 7 - Click to Enlarge

The Health Care Sector rallied nicely into the end of the year and is up 44% from the March 2009 lows. Currently, it is down 9% from its recent highs, which is not much worse than the summer’s 6% drop. The long-term weekly chart shows that the rally has just reached the former uptrend, line b, which is a troubling development. A convincing close above 385 is needed to reassert the uptrend. The steep uptrend, line c, is now being tested, but there is a band of stronger support, including the rising 40-week MA, in the 325-340 area. The RS chart shows the breakout above major resistance, line d, in the fall of 2008 (point 1). The weekly RS dropped back below its WMA in March as the overall market turned around and investors became less defensive. Over the past few months, the WMA has started to turn up and the RS has formed higher highs.

Figure 8 - Click to Enlarge

Despite fears that consumer spending would never recover, the chart of the Consumer Discretionary Sector looks pretty good, up 89% from the March lows and 39% for the year. So far, it is holding pretty well during the correction, and there is a band of strong support in the 210-220 area, which includes the 40-week MA. The major 61.8% resistance is at 245, which is not far above the recent highs. The RS completed a classic bottom formation in late March (point 1). The RS had diverged from prices at the March lows (line e), and this was confirmed by the break of the two-year downtrend, line d. It is encouraging that the RS is rising and holding above its rising WMA.

Figure 9 - Click to Enlarge

Cleary the toughest sector to analyze recently has been the Energy sector, and it has corrected sharply from the recent highs. The 200-day MA and the shallow uptrend from the March lows (line b) have recently been violated (see point 1). This suggests that the entire rally from the 2009 lows could be just a continuation pattern, lines a and b. The next good chart and retracement support is in the 370-385 area. They RS chart does not look any more positive as the multi-year uptrend, line d, was broken last summer (point 2). The daily RS shows a well-established downtrend, line 2, and it would take an impressive rally to turn it around.

NEXT: Telecom and Select Subgroups to Watch

|pagebreak|

Figure 10 - Click to Enlarge

The Telecommunications Services sector also looks quite vulnerable as it has closed below weekly support at line b. It had an anemic performance in 2009, up just 3%, and is down 15% from its recent highs. The next key level of support is in the 85-95 area.

The RS chart turned positive in October 2008 as this sector stayed fairly stable for next six months while most of the other sectors crashed. The RS is currently in a well-established downtrend, line d, but it could turn around in the next several weeks. A sharp improvement in the RS would be consistent with deeper market correction. The Utilities sector also looks weak, as after a breakout in early December (click here for chart), it has reversed sharply.

Figure 11 - Click to Enlarge

Two industry groups that look interesting are Photographic Products and Building Products. The Photographic Products are part of the Consumer Discretionary sector, and the daily chart shows a potential bottom formation, lines a and b. A strong move above 13.50 would complete the bottom, suggesting a move to 21.50 if not the 38.2% resistance at 25.00. The RS chart shows also shows a bottoming formation as the daily RS is positive. A move through the resistance at line c would confirm it is a market leader.

The Building Products are part of the Industrial sector, and on the weekly chart, we see a reverse head-and-shoulders bottom formation as the neckline was overcome in July. The action over the past five months, lines f and g, appears to be a continuation pattern. The long-term downtrend is at 165 with the head-and-shoulders targets in the 180-185 area. The Homebuilders also show a potential bottoming formation, but it has not yet been confirmed.

Over the next four to six weeks, we should get a better idea of the overall trend in the stock market. The key factor, in my opinion, will be the strength of the first rebound after a short-term low is in place. The best case scenario is for a decent rebound that could retrace 50% of the recent decline followed by more selling that could take us to the recent lows or lower. Alternatively, the market could rally from current levels and make new highs with most of the sectors also making new highs. This scenario would weaken the intermediate term outlook. Stay tuned!!