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By Corey Rosenbloom | March 28, 2012 | 9:21 AM |  0 CommentsTweet This

What is the broader Sector Rotation Model saying about the current rally and state of the market?

Good things actually.

Let’s take a moment to view the current Sector Rotation Performance from three perspectives, starting with Absolute Performance so far in 2012:

To recap, the Sector Rotation Model breaks down the broader market into nine sectors as represented above with the tradable AMEX Sector SPDRs (XLK for Technology for example).

These nine sectors are divided into two broad categories:

By assessing which sectors are outperforming, a trader or investor can get a sense of the broader stock market and economy.

In addition, savvy traders can scan to locate the strongest relative stocks in the strongest relative sectors for short-term trading opportunities (go with the winners!).

Ok, so what is the Model saying?

This is the picture of Bullish Strength – mainly in terms of the strong outperformance (greatest percentage increase in 2012) coming from the aggressive/offensive sectors of Financials (XLF), Technology (XLK), and Consumer Discretionary/Retail (XLY).

By the same token, the weakest sector performance comes from the Defensive sectors of Consumer Staples (XLP), Health Care (XLP) and a slight negative return (down 2.3%) for Utilities (XLU).

Energy – despite the headlines – is also an underperformer at 5.7%.

The next chart shows the sector performance RELATIVE to the S&P 500 (which is up roughly 13%):

This is just another way to view the performance where we ‘flatline’ the S&P 500 and then view the over or under-performance (relative to the 13% mark).

This perspective gives a clearer perspective of where sector strength or weakness resides – which is clearly in the Defensive (and Energy) sectors.

This next chart is a more advanced “Line” perspective of sector performance so far in 2012:

This chart is helpful to assess the trends in price, rather than the frozen “snap-shot” in time that the other charts provide.

You can also use it to view sector “clusters,” which is where different sectors cluster or travel together.

Two examples would be the XLI and XLB cluster (with the S&P 500) near 13% and the XLP, XLE, and XLV (defensive) cluster near the 5% line.

Again, the weakest sector is – and has been – Utilities (XLU) through 2012.

We generally do best to trade WITH sector trends rather than against them – meaning it would have been far more profitable to trade long with financials so far than trying to call a top and play a reversal.

The same is true with Utilities which were weakest from the start… and continued to be weak into late March (present).

Again, to me, the surprise from teh charts above is the Energy (XLE) sector which is registering a plus 6% performance – with all the focus on oil prices, one would expect the XLE to be among the top performers.

Anyway, continue watching the current Sector Performance for…

As a follow-up to yesterday’s “Bullish Sector Rotation Model” post, let’s take a moment to clarify how investors and traders can use top-level Sector Rotation themes to their advantage.

Traders and investors often use the model – or at least compare sector relative performance – to pinpoint trading or investing opportunities from the strongest stocks in the strongest sectors during bull/rally phases in the market.

The alternate strategy would be to locate the weakest stocks in the weakest sectors during a down or bear phase in the market.

As mentioned in the prior update, the Financial and Technology sectors – as viewed using the AMEX Sector ETFs XLF and XLK – are the top performers so far in 2012 (year to date to the end of March 2012).

Let’s take it one step further and view the largest five stocks in these two leading ETFs, first with Technology (XLK):

The chart above shows the price performance of five leading Technology stocks so far in 2012.

While the XLK – broader Technology ETF – is up 20% year to date, some stocks rose more than that while other technology stocks did not rise as much.

Generally speaking, the best trading and investment opportunities develop from the stronger stocks in a strong sector, which can be defined using Fundamental Analysis or even Technical Analysis (charting trends and relative performance).

You want to put your money in the best stocks in sectors that are outperforming the broader market – and at a minimum, avoid buying the weakest stocks in the weakest sectors.

This type of logic is along the lines of the phrase “Buy High, Sell Higher.”

Anyway, it should be no surprise that the top performer in the group is Apple (AAPL) but it may be surprising to learn that Google (GOOG) is the underperformer so far – notching only a 1.5% gain so far in 2012.

The image below helps us visualize a stock’s location not just within its sector, but within the broader market as well:

If we start with the broader market, we can then break the market down into nine (or ten) major sectors.

At times in the business/economic cycle, certain sectors will outperform others – and the broader stock market as well.

Individual stocks group together to make up the sectors, which are tracked easily using the AMEX Sector SPDR ETFs.

There’s a variety of ways to view both sector and stock performance, and it can be helpful to take the time to do so – visualizing each stock as part of a broader picture (its sector) which then is part of the Stock Market as a whole.

Here’s a performance chart for the other Sector leader in 2012:  The Financial Sector (XLF)

We see a similar picture in Financials as we see in Technology – Bank of America (BAC) outperformed the other leading companies in the sector, while Berkshire Hathaway (BRK/B) was an under-performer so far.

While the broader Sector ETF is up 22%, some stocks rose well above that amount year to date.

Notice also that Bank of America – BAC – started the year in the strongest position and remains there as of the end of March.

Berkshire Hathaway started the weakest stock in this ‘top 5′ list and is currently positioned there as well.

And finally, let’s take a quick look at the Utilities (XLU) Sector, which has been this year’s under-performer into March:

Again, the broader XLU Sector ETF is down 2.2% year to date and most of the ‘big five’ stocks in the ETF are also down for the year.

Keep in mind that the Utilities Sector is a Defensive/Protective sector group and is expected to under-perform during periods of stock market bullishness/rallies.

The under-performer in the group so far is Exelon (EXC) while the “out-performer” is NextEra Energy (NEE).

The main lesson to me is that we shouldn’t try to pick the best stock in a bad sector – the only leading stock that is positive for the year is NEE which is up less than 1%.

Contrast this with the worst “top 5″ performer in Technology – Google – which is up 1.5% and the worst “top 5″ Financial performer – Berkshire Hathaway – up almost 7%.

We’re reminded again that “The Trend is Your Friend” – particularly with sector trends and performance relative to the broader market.

Swing Traders in particular can benefit from taking the extra step to analyze sector and leading stock performance.