Technical Tuesday: Trouble Ahead?

by Christopher Rowe, Technical Strategist, The Oxford Club Technical Analysis Technical Analysis
Stock market graph on a tablet computer

Whenever a bull market corrects, investors ask themselves: Could this bull run be over?

Today I'll give you one big indication that historically has spelled the end.

Very simply, when the sector that had led the market breaks down, it's a major sign of a long-term top. Do you know which sector led the current bull market higher?

I'll get to that in a minute, but first, a little history about the two previous bull markets...

2002-2007

The bull market from 2002 to 2007 was led by the financial sector. Low interest rates sparked the run-up in real estate and the creation of leveraged investment vehicles that ultimately led to the global credit crisis.

Sure, commodity stocks and utility stocks outperformed the financial sector by two- or threefold, but due to the heavy weighting of financial stocks on the major market averages, that sector had the biggest influence on the bull market.

We saw the sector lose strength and then break down in the first half of 2007. The decline was especially pronounced in the second half of that year.

1994-2000

Tech stocks led the bull market higher in the late 1990s. The majority of small cap stocks began topping out in the first half of 1998 as the heavily weighted technology sector went parabolic. The market charged higher for a while. But as soon as tech stocks cracked in March 2000, that was a clear warning sign of the stock market top.

2009-Present

That brings us to today.

The "consumer discretionary" sector is the major S&P sector that led the market higher in 2013.

Below is a chart showing the 2013 performance of all nine S&P 500 sector ETFs. What the chart refers to as "Cyclicals" is actually the Consumer Discretionary SPDR ETF (NYSE: XLY). Notice how it was the best performer last year with a 42%+ gain.

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Below is another chart from the key market low set on Oct. 4, 2011, to Dec. 31, 2013. Note the same sector is the leader since that period, up 97%.

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Finally, take a look at the performance of January 2014. The consumer discretionary sector was the worst performing sector last month.

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We can't expect this sort of indicator to always show us the exact top of the market. Alex Green wrote a great piece yesterday about the big risk and negative impact of being a market timer.

But it pays to watch the key leading sector in a bull market to get a sense for when is the best time to hedge your positions.

By following the long-term trends, we have plenty of time to act when we see evidence pile up that a long-term trend might be near its end.

Let's keep a close watch on the consumer discretionary sector for 2014. I'll keep you posted on what I'm seeing in some of my future articles. And I would love to hear your opinion on this topic, so feel free to comment by clicking the link below.

Good investing,

Chris

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