2 Proven Ways to Analyze the Markets

03/08/2012 1:00 pm EST


Corey Rosenbloom

Founder and President, Afraid to Trade

Corey Rosenbloom explains how some traders use sector rotation and intermarket analysis to discern important signals on a variety of popular markets.

We’re taking a look at sector rotation and intermarket analysis with Corey Rosenbloom. Corey, you’ve done a lot of work on that. What’s the importance of first, sector rotation?

Sector rotation is a broad-based way to look at the markets, as opposed to, say, the Dow Jones 30 stocks or the S&P 500.

What we’re looking at is inside the market in the individual sectors. I’m looking at nine, some look at ten. They divide technology, or they divide things in different ways. I look at nine major sectors on the AMX sector SPDRs. So, XLV would be healthcare, XLP is (consumer) staples, XLF is financials.

We chart those and look at their trends and look at if there’s anything outperforming the S&P. In other words, is there a sector, or a group of sectors, outperforming the market—or underperforming, that’s of good interest.

See related: Easily Identify the Strongest Sectors

If, for example, we divide those nine sectors into defensive sectors, those would be health care, staples, utilities, and the remainder will be offensive, or aggressive sectors, where the money managers rotate when they think the market is going higher so they get better performance there.

That gives us a broader basis to look at the markets. The “risk-on” crowd would say the advancing sectors are those that are the aggressive ones. That’s good for the broader market.

Like financials or something like that.

Yes, absolutely. Financials, technology, consumer discretionary, etc.

How about the intermarket analysis? What’s the importance of that in trading?

Intermarket analysis takes the picture even further. So, the stock market we can divide lower into sectors, and of course, industry groups, but we raise higher and take that as one market, the actual stock market.

Then we go to look at gold, the dollar, oil, bonds, other currencies, other foreign exchanges. So, we’ll see them as the stock market itself, which can be subdivided as one part of a larger, global structure.

Oil, because it works on global economic demands, when demand is higher, prices go up. If economic conditions are good, look at oil and commodities that go with the stock market.

In market turmoil or volatility, people go to bonds and away from stocks, or away from commodities and into safer havens. We say the dollar is that as well.

So, in the intermarket picture, we have risk-on markets, which would be, for example, among others, stocks and commodities, and risk-off would be the US dollar index as a safe haven and Treasuries.

See related: “Risk-on” and “Risk-off” Trades

And what do you do in a situation where they’re all moving in lockstep? It doesn’t happen often, but we have seen it. 

We have seen it, and that’s what happens with risk. The worst case I can remember recently was 2008, when everything was falling. Literally everything with the exception of one thing, and that was the US dollar.

People were flooding into that currency and really just pulling out of everything they had in the market, taking profits, or just liquidating losses. If there were no profits from positions established years ago, then there were losses from things established in 2007 or early 2008.

That was a violent, very uncharacteristic, rare, one-market thesis, or one-market movement. It was liquidation; sell everything, panic; like the world is going to melt down.

Well, the world did not melt down, of course, but it was “sell first and ask questions later.” The one thing that benefited from that was the dollar. Even Treasuries were sold at that time.

How does that overlay on your current trading strategies now?

Right now, three years later, we’re looking in terms of the same thing.

So, the S&P’s trajectory is higher, as are commodities, boosted, of course, by quantitative easing and basically a Fed policy action to keep interest rates as low as they could possibly keep them. That’s supportive for commodities; that’s supportive for stocks, and they continue to be the lender of last resort.

That has to be taken into account now. I don’t know if there’s anything changing in that scenario. If the Fed decides that it needs to go more towards inflation control and inflation gets too out of hand, then we’ll begin to change.

That’s not the case as it is right now. Inflation is high, but moderate, so the Fed is taking a more actionary approach to stimulate the economy because unemployment is so high.

I think even in the intermarket scenario, one has to look at in terms of central bank action, so that’s supportive for commodities, supportive for stocks, and not-so-supportive for the dollar.

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