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RATE OF CHANGE


What Do Sector Rankings Tell Us About the Economy?

06/02/03 01:57:57 PM
by Matt Blackman

The jury may still be out among analysts regarding whether this rally will be sustained or not but a look at the sectors tells a revealing tale about the state of the economy.

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Interest-sensitive sectors and consumer-based industries are generally the early leaders out of the gate in an economic recovery. These include consumer cyclicals (homebuilders, home furnishing, car manufacturers, restaurants) and energy providers that we'll call group 1.

As the cycle matures, group 2, made up of basic materials (mining, forest products, precious metals, steel) and technology (computer, biotechnology, aerospace, defense and medical), is next. At this point interest rates have generally begun to rise.

At full maturity as the cycle becomes a little longer of tooth, group 3 consisting of industrials (transportation companies, heavy construction, equipment manufacturers) and financials (banks, finance companies, insurance, real estate) lead the pack.

Finally, the economy begins to lose steam. At this point, sectors that lagged now pull into the lead. Group 4 consist of consumer non-cyclicals (beverages, healthcare, tobacco, pharmaceuticals) and utilities (electric, gas, water).

A recent scan of the sectors and industries using the SpyGlass plug-in for MetaStock reveals that leaders are currently from group 4 (tobacco), group 1 (homebuilders), group 4 again (utilities) and group 2 (biotechs). The following chart shows the top ten sectors and industries ranked by rate of change (ROC).


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SpyGlass folder averages provided by Debry.com. Sector data by Paritech.com

While this may seem somewhat confusing, it makes perfect sense given the fundamentals. Tobacco has only moved into the lead due to a recent favorable court ruling (Engel case) throwing out an astronomical punitive settlement against the tobacco industry. Homebuilding has been and continues to benefit thanks to the lowest interest rates in 40 years. Low rates (and declining energy costs post Iraq war) are also benefiting utilities.

In the last 30 days, biotechs are leading, up 24%, well ahead of homebuilders, up 18%.

Figure 1 Daily chart of biotechnologies showing a break above the trendline at $10.35. It is also above its 10-, 20-, 40- and 200-day moving averages. Note the volume spike in the middle of May followed by a breakout. Chart provided by MetaStock.com. Sector averages by Debry.com makers of SpyGlass.
 
An understanding of the intermarket relationship between stocks, bonds and commodities and how sectors and industries benefit in various economic environments is essential to helping find stocks in the best performing industries. Normally bonds lead in an economic cycle followed by stocks and then commodities but we are not in a normal economic environment.

Based on sectors in the lead, the economy is currently stuck in the early stages of recovery. Until demand picks up, industry will continue to rely on low interest rates to get and stay profitable. I am looking for industries that will continue to benefit from low rates as there is no sign of a rise in rates anytime soon, especially given the predominant emphasis by the Bush Administration on a robust economy going into the next US presidential election in November 2004.

Biotechs should also continue to do well in a world where the demand for cancer fighting and other age-related illnesses increases with a maturing population.

The next phase should be heralded by a drop in bonds (as yields = interest rates increase) and continued increase in stocks, assuming the recent rise in stocks is not just another short-lived bear rally.

SUGGEST READING:

[1997] Huebott, Paul and Carole, The Fundamentals of Sector Rotation: Stocks & Commodities V15:2

Industry Group Data
http://www.debry.com/industrygroups.htm



Matt Blackman

Matt Blackman is a full-time technical and financial writer and trader. He produces corporate and financial newsletters, and assists clients in getting published in the mainstream media. He is the host of TradeSystemGuru.com. Matt has earned the Chartered Market Technician (CMT) designation. Find out what stocks and futures Matt is watching on Twitter at www.twitter.com/RatioTrade

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