foxex: Sector Rotation

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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Friday, May 29, 2020

1. Nasdaq lags for the week as money shifts

2. Bonds rebound and rates fall

3. Basic materials sector rising

Market Moves

Over the course of the week an interesting pattern emerged. Stocks that had been leading since the March low points began to stall and sell off midway through the trading day, and several beleaguered sectors began to rise. This evidence of sector rotation is important in a rebound or bull market rally. As Investopedia Academy instructor J. C. Parets explained in his latest blog entry, "When the past leaders take a break, and new leadership emerges, this is a classic characteristic of a bull market."

Even though the Nasdaq 100 (NDX) closed 1.5 percent higher for the week, the S&P 500 index (SPX), Dow Jones Industrial Average (DJI) and the Russell 2000 index (RUT) all closed over three percent higher for the week. The chart below compares State Street's S&P 500 index ETF (SPY), the blue line in the middle, with each of that company's sector index ETFs including those for Energy (XLE), Consumer Discretionary (XLY), Basic Materials (XLB), Healthcare (XLV), Technology (XLK), Utilities (XLU), Industrials (XLI), Finance (XLF), and Consumer Staples (XLP). It's not hard to make an explanation for this current order considering the pandemic's impact. What is important to notice is the sectors making the strongest run over the last two weeks. Chart watchers can tell they need to pay close attention to XLY and XLB in the days ahead.

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Bonds Rebound and Rates Fall

Bond prices rebounded today which means that interest rates, which are inversely correlated, fell enough to maintain their sideways trend. This is an important trend for first-time homebuyers who might be looking to purchase a home this summer. Lending rates haven't been this favorable in decades. The flip side of this phenomenon is that house prices are likely to rise as available dollars chase the same new and existing homes.

The chart below compares share prices of State Street's homebuilder index ETF (XHB) with the DJ Wilshire Global Real Estate ETF (RWO) and the DJ Wilshire International Real Estate ETF (RWX). Worldwide real estate trends are only mildly upward, but in the U.S., where home ownership is still a way of life, the trend is strongly higher. The importance of all three of these ETF trends is that they signal no weakness in demand for real estate. This in turn signals no liquidity problems for the financial system over time, and that means a bullish trend for stocks is free to continue.

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Basic Materials Sector Rising

If homebuilding and real estate construction are going to continue, it is no surprise that the basic materials sector (XLB) is doing well and likely to continue rising. What may be a surprise, however, is which companies are leading the charge. The chart below compares one of the ETF's top holdings, Ecolab Incorporated (ECL) with the sector ETF. The importance here is that ECL is making new highs, and the economy hasn't even fully rebounded yet. Just imagine what will happen to this and other stocks when the economic rebound is fully underway worldwide. That thought is precisely what investors are anticipating, which provides evidence of continued bullish moves to come.

The Bottom Line

Stock indexes showed evidence of sector rotation this week as the other major indexes outperformed the Nasdaq 100. Interest rates maintained their low and sideways trajectory, implying highly affordable loans for home buyers, especially first time buyers, throughout the summer. This available money should work its way into the economy and help the recovery through various venues such as the basic materials sector.