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Does the Stock Market Believe the US is Going Over the Cliff?
One tenet of stock market wisdom — usually referred to as "sector rotation" — holds that we can discern the market's mood by studying the relative price changes of stocks in different sectors. The chart below depicts this idea. The financial cycle is thought to lead the business cycle by 6-9 months. When certain sectors surge ahead — like Financial and Technology stocks — the business cycle is believed to be in early to full stage recession. On the other hand, when stocks in Cyclical sectors, like Industrials, surge ahead, the business cycle should be in the early stages of expansion.
Examining US stock returns by sector from the past 90 days in the chart below, we see that Financial and Industrial stocks both held up well and recovered the best since the November 2012 market malaise. Note the mixed message — when Financials surge ahead, we're supposed to be in the early stages of a recession. But when Industrials lead the market, we're supposed to be in the early stages of expansion.
When markets are functioning properly, we should to be able to glean a little wisdom from studying the price changes of the lagging sectors as well. As the above chart shows, classic risk-on sectors like Energy and Technology continue to exert a drag on the market — another sign that traders believe the economy is expected to weaken somewhat in early 2013. Overall, traders are probably having a difficult time processing the irrational signals coming out of Washington regarding the fiscal cliff. The market is not sending clear signals whether the big trade in early 2013 will be risk-on or risk-off.
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